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Quentin Metsys, Moneychanger and his Wife, 1514 Economics 2

Lecture 23: Perfect Competition in the Long Run

the shutdown decision
firm's short-run supply curve zero long run profits
consumer surplus
producer surplus

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The Shutdown Decision

In the short-run, certain costs, such as rent on land and equipment, must be paid whether or not any output is produced. These are the firm's fixed costs. When the firm is deciding whether or not to produce any output at all (the level of output is given by MR=P=MC), the firm looks only at its variable costs. The firm will produce if it can earn sufficient revenue to pay the variable costs.

Firm's Short-Run Supply Curve

Recall that a perfectly competitive firm in the short run will

short run supply curve The short-run supply curve of a perfectly competitive firm is the portion of its Marginal Cost curve above the Average Variable Cost curve.

Zero Long Run Profits

In the long-run, firms can enter and exit the industry. Economic profits will encourage firms to enter the industry. The increase in the number of sellers will increase supply and cause the market price to fall until the profits disappear. Firms will leave the industry when economic losses are being incurred. The decrease in the number of sellers decreases supply and causes the price to rise until the losses vanish. In the long run, firms in a perfectly competitive market earn zero economic profit. Also, in the long run, the price in a perfectly competitive market will equal the minimum of long-run average costs. Firms will be producing the good at the least cost. Therefore, perfect competition results in economic efficiency.

long-run equilibrium

Consumer Surplus

Recall from chapter 6 that the demand curve measures the value an individual places on each unit of the good. The height of the demand curve shows the amount she is willing to pay for an additional unit of the good.

consumer surplus

The consumer pays less than she would be willing to for the good. Consumer surplus is the difference between what a consumer is willing to pay and the market price of the good.

Producer Surplus

The height of the supply curve measures the cost of producing an additional unit of the good. This is the lowest price the firm is willing to accept for an additional unit of the product.

Producer surplus is the difference between the price firms would have been willing to accept and the price they actually receive. Graphically, producer surplus is the area above the supply curve below the market price.

producer surplus

Consumer surplus is the area below the demand curve above the market price. The sum of consumer surplus and producer surplus is the total surplus. When the total surplus increases, society is better off.

The total suplus is maximized at the market equilibrium quantity. Since a perfectly competitive market produces the market equilibrium quantity, perfect competition maximizes the sum of consumer and producer surplus.

1794 U.S. 
silver dollar David A. Latzko
Business and Economics Division
Pennsylvania State University, York Campus
office: 13 Main Classroom Building
phone: (717) 771-4115
fax: (717) 771-4062
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