Long Run Equilibrium
(A) Firm and Industry: A competitive market is made up of a large number of firms with complete freedom of entry. Such firms together are called competitive industry. An industry can be defined as a group of firms producing homogeneous products with freedom of entry and exit and which earn only normal profits. Hence the concept of an industry is applicable only under competitive conditions. There is no fixed size of an industry though the analytical stability of an industry can be stated. An industry is said to be stable and in equilibrium when in the long run all adjustments have been made and there is neither tendency for outside firms to enter nor tendency for inside firms to exit; hence each firm makes only normal profits. (B) Market Supply Curve: Before we analyze the long run market equilibrium of a competitive industry let us begin with the demand and supply curves. The market demand curve under competitive industry conditions is downward sloping. Its supply curve is governed by the cost structure. [pic]
In Figure 35 we have Average and Marginal Cost curves of a firm. Marginal Cost curve intersects Average Total Cost curve at a minimum point. A rational profit maximizing firm is supposed to arrive at a point such as S and produce output Q. Since for smaller output levels Average Cost is still falling and for larger output levels Average Cost is rising, at initial point S Average Cost C1 = Price P. At price P a firm’s supply is Q. If a firm is required to make additional supply such as Q1 it will expect to cover its additional or Marginal Cost as S1 = C1. Supply will increase only when C1 = price P1 in the market i.aspsing. The law of supply is therefore a direct relation between price and supply. Higher the price (P1) greater the supply. A firm’s supply curve is equiv.aspt to its Marginal Cost curve. To construct market supply curves of a firm we have to make a lateral summation of the supply of firms. Therefore the market supply...
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