Long Run Equilibrium: Videos & Practice Problems

Long-run equilibrium in perfect competition occurs when the market price equals the minimum average total cost (${\mathrm{ATC}}_{}$) of production. At this point, firms earn zero economic profit because price ($P$) equals average total cost, meaning all costs, including opportunity costs, are covered. In this state, firms produce at the quantity where marginal cost ($\mathrm{MC}$) equals marginal revenue ($\mathrm{MR}$), which also equals price. No new firms have an incentive to enter or exit the market, so the market supply and demand are balanced. This equilibrium ensures efficient resource allocation and stable market conditions in the long run.

An increase in demand shifts the demand curve to the right, causing a higher market price and quantity in the short run. This higher price allows firms to earn economic profits because price exceeds average total cost (${\mathrm{ATC}}_{}$). These profits attract new firms to enter the market, increasing the market supply. As supply increases, the supply curve shifts right, pushing the price back down toward the minimum ${\mathrm{ATC}}_{}$. This process continues until economic profits are eliminated, and the market returns to a new long-run equilibrium where price equals minimum ${\mathrm{ATC}}_{}$. The quantity supplied is higher, but firms individually produce at the same efficient scale as before.

In perfect competition, firms earn zero economic profit in the long run because of free entry and exit. When firms earn positive economic profits, new firms enter the market, increasing supply and driving the price down. Conversely, if firms incur losses, some exit, reducing supply and raising the price. This entry and exit continue until price equals the minimum average total cost (${\mathrm{ATC}}_{}$), where firms cover all costs, including opportunity costs, but earn no extra profit. At this point, firms produce at the efficient scale, and no incentive exists for further entry or exit, stabilizing the market.

In long-run equilibrium under perfect competition, firms produce where marginal cost ($\mathrm{MC}$) equals marginal revenue ($\mathrm{MR}$), and both equal the market price ($P$). Since firms are price takers, $\mathrm{MR}$ equals $P$. Producing at this point maximizes profit or minimizes loss. Additionally, this quantity corresponds to the minimum average total cost (${\mathrm{ATC}}_{}$), ensuring zero economic profit. This condition ensures efficient production and resource allocation in the long run.

After a demand shock, such as an increase in demand, firms initially earn economic profits due to higher prices. This attracts new firms to enter the market, increasing supply. As supply rises, the market price falls, reducing profits. Entry continues until profits are eliminated, restoring long-run equilibrium where price equals minimum average total cost (${\mathrm{ATC}}_{}$). Conversely, if demand decreases, firms incur losses, causing some to exit, reducing supply and raising prices until losses disappear. Thus, firm entry and exit are key mechanisms that adjust supply to restore equilibrium after demand changes.