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Show, by means of two separate labelled diagrams, the short run and long run equilibrium positions of a profit maximizing firm in perfect competition - Leaving Cert Economics - Question 2 - 2017
Question 2
Show, by means of two separate labelled diagrams, the short run and long run equilibrium positions of a profit maximizing firm in perfect competition. Compare the s... show full transcript
Worked Solution & Example Answer:Show, by means of two separate labelled diagrams, the short run and long run equilibrium positions of a profit maximizing firm in perfect competition - Leaving Cert Economics - Question 2 - 2017
Step 1
Show, by means of two separate labelled diagrams, the short run and long run equilibrium positions of a profit maximizing firm in perfect competition.
Answer
To illustrate the equilibrium positions of a profit-maximizing firm in perfect competition, we will draw two separate diagrams: one for the short run and one for the long run.
Short Run Diagram
In the short run, the firm maximizes profit where marginal cost (MC) equals marginal revenue (MR). The equilibrium occurs at point A, where the price (P1) intersects the demand curve (D) and the MR curve. The average cost (AC) curve is drawn to show that the price is above the average total cost, indicating that the firm earns supernormal profits.
- The diagram includes:
- The demand curve (D) and the marginal revenue curve (MR)
- The marginal cost curve (MC)
- The average cost curve (AC)
- Equilibrium output (Q1) where P1 = MR = MC.
Long Run Diagram
In the long run, the firm achieves a different equilibrium because of the entry of new firms into the market. The equilibrium price is lower (P2) and intersects the average cost curve at its minimum point. In the long run, firms make normal profits as price equals average cost.
- The diagram includes:
- The long-run marginal revenue (MR2) and average revenue (AR2)
- The long-run cost curves (MC, AC)
- Equilibrium output (Q2) where MR2 = AR2 = MC at the minimum point of AC.
Step 2
Compare the short run equilibrium position with the long run equilibrium position of a perfectly competitive firm under the following headings: Price and Output
Answer
In the short run, the market price is determined by the intersection of supply and demand. The firm accepts this price and maximizes profits by producing where MR = MC.
- When new firms enter the industry, the market supply increases, leading to a decrease in the market price. Therefore, the long-run equilibrium price (P2) is lower than the short-run price (P1).
- In the short run, a single firm can influence the total output, whereas in the long run, each firm contributes only a fraction of the total market output.
Step 3
Profits
Answer
In the short run, firms can earn supernormal profits (SNP) as their price exceeds average cost:
- At the equilibrium price P1, the area between P1 and AC represents the supernormal profits.
- In the long run, as new firms enter the market competing for profits, the market price falls to the level of the average cost (AR = AC), resulting in zero economic profit.
Step 4
Efficiency
Answer
In the short run, firms may have incentives to operate inefficiently as they can earn SNP.
- They do not necessarily produce at the minimum of the AC curve, as they can still cover their costs and make profits.
- In the long run, only the firms that are efficient and produce at the lowest point on the AC curve will survive in the market, ensuring productive efficiency.