Long‐Run Supply

In the long-run, firms can vary all of their input factors. The ability to vary the amount of input factors in the long-run allows for the possibility that new firms will enter the market and that some existing firms will exit the market. Recall that in a perfectly competitive market, there are no barriers to the entry and exit of firms. New firms will be tempted to enter the market if some of the existing firms in the market are earning positive economic profits. Alternatively, existing firms may choose to leave the market if they are earning losses. For these reasons, the number of firms in a perfectly competitive market is unlikely to remain unchanged in the long-run.

Zero economic profits. The entry and exit of firms, which is possible in the long-run, will eventually cause each firm's economic profits to fall to zero. Hence, in the long-run each firm earns normal profits. If some firms are earning positive economic profits in the short-run, in the long-run new firms will enter the market and the increased competition will reduce all firms' economic profits to zero. Firms that are earning negative economic profits (losses) in the short-run will have to either make some changes in their fixed factors of production in the long-run or choose to leave the market in the long-run. A perfectly competitive market achieves long-run equilibrium when all firms are earning zero economic profits and when the number of firms in the market is not changing.

Minimization of long-run average total cost. In the long-run, a perfectly competitive firm can adjust the amount it uses of all factor inputs, including those that are fixed in the short-run. For example, in the long-run, the firm can adjust the size of its factory. In making these adjustments, the firm will seek to minimize its long-run average total cost. If, in the short-run, the firm is operating below its minimum efficient scale and experiencing economies of scale, in the long-run it can adjust its use of factor inputs so as to increase its output to the minimum efficient scale level.

Alternatively, if the firm is experiencing diseconomies of scale because its short-run level of output exceeds its minimum efficient scale, in the long-run the firm can adjust its use of factor inputs so as to reduce its output to the minimum efficient scale level. Thus, in the long-run the firm will be operating at the minimum point of its long-run average total cost curve.

Graphical illustration of long-run profit maximization. The long-run equilibrium for an individual firm in a perfectly competitive market is illustrated in Figure 1 .

Figure 1 The firm's long-run profit-maximizing decision

Long-run market supply curve. The short-run market supply curve is just the horizontal summation of all the individual firm's supply curves. The long-run market supply curve is found by examining the responsiveness of short-run market supply to a change in market demand. Consider the market demand and supply curves depicted in Figures 2 (a) and 2 (b). Here, the market demand curves are labeled D₁, and D₂, while the short-run market supply curves are labeled S₁ and S₂.

Figure 2 Long-run market supply curves

Figure 2 (a) depicts demand and supply curves for a market or industry in which firms face constant costs of production as output increases. At the intersection of D₁ and S₁, the market is in long-run equilibrium at a market price of P₁. An increase in demand from D₁ to D₂ results in a new, higher market price of P₂. In the short-run, existing firms in this market will earn positive economic profits. In the long-run, however, new firms will enter, causing short-run market supply to shift from S₁ to S₂ and driving the market price back down to P₁. The long-run market supply curve is therefore given by the horizontal line at the market price, P₁

Figure 2 (b) depicts demand and supply curves for a market or industry in which firms face increasing costs of production as output increases. Starting from a market price of P₁, an increase in demand from D₁ to D₂ increases the market price to P₂. In the short-run, firms are earning positive economic profits. In the long-run, new firms will enter the market, the short-run supply curve will shift from S₁ to S₂, and the new market price will be P₃. The new, long-run market price of P₃ is greater than the old market price of P₁ because in an increasing-cost industry, the firm's average total costs rise as it produces more output. Thus, the long-run market supply curve in an increasing-cost industry will be positively sloped.

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