So far, we have considered changes in industry output that are the result of decisions by individual firms to increase or decrease output when the market price changes. In doing so, however, we have abstracted from a very important part of the reaction competitive industry on changes in demand - from the processes of entry into and exit from the industry.

Consideration of entry and exit processes implies a transition to the analysis of long-term time intervals, since short-term intervals alone do not provide the full picture. The possibility of long-term time intervals to change the volume of all types of costs (including such as the cost of land, buildings, production equipment etc.) allows the firm to independently enter the market by founding its own enterprise and hiring workers. The same opportunity allows the company to leave the market freely, paying off the employees and selling the company with all the equipment. (Sometimes firms voluntarily leave the market; in this case, the owners sell off the assets of the firm and divide the proceeds among themselves. In other cases, firms leave the market only under the influence of external forces. This happens when the creditors of the firm resort to using the decision of the arbitration court, which prescribes the forced sale of the assets of a firm unable to pay its debts.).

Free entry into the industry and equally free exit from it is one of the main features of the market of free competition. Freedom of entry, of course, does not mean that a firm can enter an industry without incurring any travel costs. Likewise, freedom of exit means that a firm intending to leave an industry will encounter no legal barriers to shutting down or relocating its operations to another region. Strictly speaking, freedom of exit means that the firm does not sunk costs. When a firm leaves an industry, it either finds a new use for its fixed assets or sells them without harm.

Free entry and exit have not yet played an active role in our discussion of how a firm makes decisions related to short-term demand. However, as we will see below, this is a condition without which it is impossible to understand the competitive market in the long run.

The firm has an enterprise whose size is just such that the short-run average total cost is exactly equal to the lowest possible long-run average cost at the chosen level of output. The short-run average total cost curve for any other enterprise size would show a higher average total cost for the chosen output. Reducing the size of the enterprise will shift the short-run average total cost curve up and to the left along the long-run average cost curve; an increase in the size of the enterprise will move it up and to the right.

Both long-run average costs and short-run average total (total) costs are equal to the price at the equilibrium level of output. This circumstance guarantees the absence of motives that encourage firms to both re-enter the market and leave it. As usual, average and total costs consist of explicit monetary and implicit costs, including the opportunity cost of capital or "normal profit". When price equals average total cost, the firm earns zero economic profit. If economic profit is positive, it will attract new firms to the industry; if it is negative, it will cause the exit of old firms from the industry.

When adding supply curves, we proceed from the assumption that the prices of all types of inputs (resources, etc.) do not change with the expansion of output. For a small firm operating in a perfect competition, this assumption is quite realistic. However, if all firms in an industry are trying to increase output at the same time, our assumption may be false. In practice, resource prices will rise unless the short-run resource supply curves (costs of all kinds) employed by the industry are perfectly elastic. If the prices of all inputs rise as the total output of the entire industry increases, the cost curves of each individual firm will shift upward as the output of all firms increases. In such a case, the short-run supply curve for the industry will have a slightly steeper slope than the curve obtained from the summation of the individual supply curves.

We have repeatedly used the term "equilibrium" to refer to a state of affairs in the economy in which economic decision makers have no incentive to change their plans. For a perfectly competitive firm to be in long-run equilibrium, the following three conditions must be met:

• 1. The firm should not have incentives to increase or decrease output in the presence of a given size of the manufacturing enterprise (that is, with a given value fixed costs used in production). This means that short run marginal cost must equal short run marginal revenue. In other words, the short-term equilibrium condition is also the long-term equilibrium condition.
• 2. Each firm must be satisfied with the size of its existing enterprise (ie, the volume of fixed costs of all types used).
• 3. There should be no incentives for firms to enter or leave the industry.

As Figure 4 shows, the price (and marginal revenue) is set at a level where it equals the minimum value of the averages total costs: P(and MR) = minATC. Since the marginal cost curve intersects the curve of average total costs at the minimum point of the latter, then at this point the marginal and average total costs are equal to each other: MC = minATC. Thus, in the equilibrium position, a comprehensive equality is indeed established: P (and MR) \u003d MC \u003d minATC.

This triple equality suggests that, although in short term a competitive firm can extract economic profit or incur losses, in the long run, carrying out production in accordance with the rule of equality of marginal revenue (price) and marginal cost (MR(=P)=MC), it earns only normal profit.

Figure 4. Long-run equilibrium position of a competitive firm: price = marginal cost = minimum average total cost.

Hence, the equality of price and minimum average total cost shows that the firm experiences the most efficient of known technologies, assigns the most low price P and produces the largest amount of output Q for the costs that it incurs. The equality of price and marginal cost indicates that resources are allocated in accordance with consumer preferences.

If at least one of these conditions is not met, then firms have good reasons to change their plans. If price does not equal short-run marginal cost, then firms will want to change the level of output while leaving the size of firms unchanged. If short-run average total cost is not equal to long-run total cost, firms will tend to change the size of enterprises. If the price is below long-run average cost, firms will simply want to leave the industry; finally, if the price exceeds the long-run costs, then firms outside the industry will have a desire to enter it.

The long-run supply curve shows the path along which the equilibrium price and output move with long-term changes in demand. In order for the movement along this curve to take place, firms must have sufficient time to both adjust the size of their manufacturing enterprises and to enter and exit the market.

Thus, the firm's equilibrium condition, both in the short run and in the long run, can be formulated as follows: MC=MR. Any profit-making firm seeks to establish a level of production that satisfies this equilibrium condition. In a perfectly competitive market, marginal revenue is always equal to price, so the firm's equilibrium condition takes the form MC = P.

AT modern economy it is virtually impossible to find a free, or perfectly competitive, market. Therefore, most often such a market is considered as a model that allows you to determine how this or that real market corresponds to the conditions of perfect competition.

Markets that do not meet the conditions of perfect competition are called markets. imperfect competition. The next chapter is about general characteristics and peculiarities of the functioning of one of the market structures of imperfect competition - pure monopoly.

A perfectly competitive market is characterized by the following features:

Firms produce the same, so that consumers do not care which manufacturer to buy it from. All products in the industry are perfect substitutes, and the cross-price elasticity of demand for any pair of firms tends to infinity:

This means that any arbitrarily small increase in the price of one producer above the market level leads to a reduction in demand for his products to zero. Thus, the difference in prices may be the only reason for preferring one or another firm. No non-price competition.

The number of economic entities in the market is unlimited, and their specific gravity so small that the decisions of an individual firm (an individual consumer) to change the volume of its sales (purchases) do not affect the market price product. In this case, of course, it is assumed that there is no collusion between sellers or buyers to obtain monopoly power in the market. The market price is the result of the combined actions of all buyers and sellers.

Freedom to enter and exit the market. There are no restrictions and barriers - there are no patents or licenses restricting activity in this industry, no significant initial investment is required, positive effect the scale of production is extremely insignificant and does not prevent the entry of new firms into the industry, there is no state intervention in the mechanism of supply and demand (subsidies, tax breaks, quotas, social programs etc.). Freedom of entry and exit absolute mobility of all resources, freedom of their movement territorially and from one type of activity to another.

Perfect Knowledge all market participants. All decisions are made in certainty. This means that all firms know their income and cost functions, the prices of all resources and all possible technologies, and all consumers have complete information about the prices of all firms. It is assumed that information is distributed instantly and free of charge.

These characteristics are so strict that there are practically no real markets that would fully satisfy them.

However, the perfect competition model:

• allows you to explore markets in which a large number of small firms sell homogeneous products, i.e. markets similar in terms of conditions to this model;

• clarifies the conditions for profit maximization;
• is the standard for evaluating the performance of the real economy.

Short-run equilibrium of a firm under perfect competition

Demand for a perfect competitor's product

Under perfect competition, the prevailing market price is established by the interaction of market demand and market supply, as shown in Fig. 1 and defines the horizontal demand curve and average income (AR) for each individual firm.

Rice. 1. The demand curve for the products of a competitor

Due to the homogeneity of products and the presence of a large number of perfect substitutes, no firm can sell its product at a price even slightly higher than the equilibrium price, Pe. On the other hand, an individual firm is very small compared to the aggregate market, and it can sell all its output at the price Pe, i.e. she has no need to sell the commodity at a price below Re. Thus, all firms sell their products at the market price Pe, determined by market demand and supply.

Income of a firm that is a perfect competitor

The horizontal demand curve for the products of an individual firm and the single market price (Pe=const) predetermine the shape of the income curves under perfect competition.

1. Total income () - the total amount of income received by the company from the sale of all its products,

represented on the graph by a linear function with a positive slope and originating at the origin, since any sold unit of output increases the volume by an amount equal to the market price!!Re??.

2. Average income () - income from the sale of a unit of production,

is determined by the equilibrium market price!!Re??, and the curve coincides with the firm's demand curve. A-priory

3. Marginal income () - additional income from the sale of one additional unit of output,

Marginal revenue is also determined by the current market price for any amount of output.

A-priory

All income functions are shown in Fig. 2.

Rice. 2. Competitor's income

Determination of the optimal output volume

Under perfect competition, the current price is set by the market, and an individual firm cannot influence it, since it is price taker. Under these conditions, the only way to increase profits is to regulate the volume of output.

Based on the existing this moment time of market and technological conditions, the firm determines optimal output volume, i.e. the volume of output that provides the firm profit maximization(or minimization if profit is not possible).

There are two interrelated methods for determining the optimum point:

1. The method of total costs - total income.

The firm's total profit is maximized at the level of output where the difference between and is as large as possible.

n=TR-TC=max

Rice. 3. Determination of the point of optimal production

On fig. 3, the optimizing volume is at the point where the tangent to the TC curve has the same slope as the TR curve. The profit function is found by subtracting TC from TR for each output. The peak of the total profit curve (p) shows the volume of output at which profit is maximized in the short run.

From the analysis of the function of total profit, it follows that total profit reaches its maximum at the volume of production at which its derivative is equal to zero, or

dp/dQ=(p)`= 0.

The derivative of the total profit function has a strictly defined economic sense is the marginal profit.

marginal profit ( MP) shows the increase in total profit with a change in output per unit.

• If Mn>0, then the total profit function grows, and additional production can increase the total profit.
• If Mn<0, то функция совокупной прибыли уменьшается, и дополнительный выпуск сократит совокупную прибыль.
• And, finally, if Мп=0, then the value of the total profit is maximum.

From the first profit maximization condition ( MP=0) the second method follows.

2. The method of marginal cost - marginal income.

• Мп=(п)`=dп/dQ,
• (n)`=dTR/dQ-dTC/dQ.

And since dTR/dQ=MR, a dTC/dQ=MC, then total profit reaches its maximum value at such a volume of output at which marginal cost equals marginal revenue:

If marginal cost is greater than marginal revenue (MC>MR), then the company can increase profits by reducing production. If marginal cost is less than marginal revenue (MC<МR), то прибыль может быть увеличена за счет расширения производства, и лишь при МС=МR прибыль достигает своего максимального значения, т.е. устанавливается равновесие.

This equality valid for any market structures, however, in conditions of perfect competition, it is somewhat modified.

Since the market price is identical to the average and marginal revenues of a firm that is a perfect competitor (РAR=MR), then the equality of marginal costs and marginal revenues is transformed into the equality of marginal costs and prices:

Example 1. Finding the optimal volume of output in conditions of perfect competition.

The firm operates under perfect competition. Current market price Р=20 c.u. The total cost function has the form TC=75+17Q+4Q2.

It is required to determine the optimal output volume.

Solution (1 way):

To find the optimal volume, we calculate MC and MR, and equate them to each other.

• 1. MR=P*=20.
• 2. MS=(TC)`=17+8Q.
• 3.MC=MR.
• 20=17+8Q.
• 8Q=3.
• Q=3/8.

Thus, the optimal volume is Q*=3/8.

Solution (2 way):

The optimal volume can also be found by equating the marginal profit to zero.

• 1. Find the total income: TR=P*Q=20Q
• 2. Find the function of total profit:
• n=TR-TC,
• n=20Q-(75+17Q+4Q2)=3Q-4Q2-75.
• 3. We define the marginal profit function:
• Mn=(n)`=3-8Q,
• and then equate Mn to zero.
• 3-8Q=0;
• Q=3/8.

Solving this equation, we got the same result.

Short-term benefit condition

The total profit of the enterprise can be estimated in two ways:

• P=TR-TC;
• P=(P-ATS)Q.

If we divide the second equality by Q, then we get the expression

characterizing the average profit, or profit per unit of output.

It follows that a firm's profit (or loss) in the short run depends on the ratio of its average total cost (ATC) at the point of optimal production Q* and the current market price (at which the firm, a perfect competitor, is forced to trade).

The following options are possible:

if P*>ATC, then the firm has a positive economic profit in the short run;

Positive economic profit

In the figure, total profit corresponds to the area of ​​the shaded rectangle, and average profit (ie profit per unit of output) is determined by the vertical distance between P and ATC. It is important to note that at the optimum point Q*, when MC=MR, and the total profit reaches its maximum value, n=max, the average profit is not maximum, since it is determined not by the ratio of MC and MR, but by the ratio of P and ATC.

if R*<АТС, то фирма имеет в краткосрочном периоде отрицательную экономическую прибыль (убытки);

Negative economic profit (loss)

if P*=ATC, then economic profit is zero, production is breakeven, and the firm earns only normal profit.

Zero economic profit

Termination Condition

In conditions when the current market price does not bring positive economic profit in the short term, the firm faces a choice:

• or continue unprofitable production,
• or temporarily suspend its production, but incur losses in the amount of fixed costs ( FC) production.

The company makes a decision on this issue based on the ratio of its average variable cost (AVC) and market price.

When a firm decides to close, its total earnings ( TR) fall to zero, and the resulting losses become equal to its total fixed costs. Therefore, until price is greater than average variable cost

P>AVC,

firm production should continue. In this case, the income received will cover all the variables and at least part of the fixed costs, i.e. losses will be less than at closing.

If price equals average variable cost

then from the point of view of minimizing losses to the firm indifferent, continue or stop its production. However, most likely the company will continue its activities in order not to lose its customers and keep the jobs of employees. At the same time, its losses will not be higher than at closing.

And finally, if prices are less than average variable costs the firm should cease operations. In this case, she will be able to avoid unnecessary losses.

Production termination condition

Let us prove the validity of these arguments.

A-priory, n=TR-TS. If a firm maximizes its profit by producing the nth number of products, then this profit ( n) must be greater than or equal to the profit of the firm under the conditions of closing the enterprise ( on), because otherwise the entrepreneur will immediately close his enterprise.

In other words,

Thus, the firm will continue to operate only as long as the market price is greater than or equal to its average variable cost. Only under these conditions, the firm minimizes its losses in the short run, continuing to operate.

Intermediate conclusions for this section:

Equality MS=MR, as well as the equality MP=0 show the optimal output volume (i.e., the volume that maximizes profits and minimizes losses for the firm).

The ratio between the price ( R) and average total cost ( ATS) shows the amount of profit or loss per unit of output while continuing production.

The ratio between the price ( R) and average variable costs ( AVC) determines whether or not to continue activities in the event of unprofitable production.

Competitor's short run supply curve

A-priory, supply curve reflects the supply function and shows the amount of goods and services that producers are willing to supply to the market at given prices, at a given time and place.

To determine the short-run supply curve of a perfectly competitive firm,

Competitor's supply curve

Let's assume that the market price is Ro, and the average and marginal cost curves look like those in Fig. 4.8.

Insofar as Ro(closing points), then the firm's supply is zero. If the market price rises to a higher level, then the equilibrium output will be determined by the relation MC and MR. The very point of the supply curve ( Q;P) will lie on the marginal cost curve.

By successively raising the market price and connecting the resulting points, we get a short-run supply curve. As can be seen from the presented Fig. 4.8, for a firm-perfect competitor, the short-run supply curve coincides with its marginal cost curve ( MS) above the minimum level of average variable costs ( AVC). At lower than min AVC level of market prices, the supply curve coincides with the price axis.

Example 2: Defining a sentence function

It is known that a firm-perfect competitor has total (TC), total variable (TVC) costs represented by the following equations:

• TS=10+6 Q-2 Q 2 +(1/3) Q 3 , where TFC=10;
• TVC=6 Q-2 Q 2 +(1/3) Q 3 .

Determine the firm's supply function under perfect competition.

1. Find MS:

MS=(TC)`=(VC)`=6-4Q+Q 2 =2+(Q-2) 2 .

2. Equate MC to the market price (condition of market equilibrium under perfect competition MC=MR=P*) and get:

2+(Q-2) 2 = P or

Q=2(P-2) 1/2 , if R2.

However, we know from the preceding material that the supply quantity Q=0 for P

Q=S(P) at Pmin AVC.

3. Determine the volume at which the average variable costs minimal:

• min AVC=(TVC)/ Q=6-2 Q+(1/3) Q 2 ;
• (AVC)`= dAVC/ dQ=0;
• -2+(2/3) Q=0;
• Q=3,

those. average variable costs reach their minimum at a given volume.

4. Determine what min AVC equals by substituting Q=3 into the min AVC equation.

• min AVC=6-2(3)+(1/3)(3) 2 =3.

5. Thus, the firm's supply function will be:

• Q=2+(P-2) 1/2 ,if P3;
• Q=0 if R<3.

Long-run market equilibrium under perfect competition

Long term

So far, we have considered the short-term period, which involves:

• the existence of a constant number of firms in the industry;
• enterprises have a certain amount of permanent resources.

In the long term:

• all resources are variable, which means the possibility for a firm operating in the market to change the size of production, introduce new technology, modify products;
• a change in the number of enterprises in the industry (if the profit received by the firm is below normal and negative forecasts for the future prevail, the enterprise may close and leave the market, and vice versa, if the profit in the industry is high enough, an influx of new companies is possible).

Main assumptions of the analysis

To simplify the analysis, suppose that the industry consists of n typical enterprises with same cost structure, and that the change in the output of incumbent firms or the change in their number do not affect resource prices(we will remove this assumption later).

Let the market price P1 determined by the interaction of market demand ( D1) and market supply ( S1). The cost structure of a typical firm in the short run has the form of curves SATC1 and SMC1(Fig. 4.9).

Rice. 9. Long run equilibrium of a perfectly competitive industry

The mechanism of formation of long-term equilibrium

Under these conditions, the firm's optimal output in the short run is q1 units. The production of this volume provides the company positive economic profit, since the market price (P1) exceeds the firm's average short-term cost (SATC1).

Availability short-term positive profit leads to two interrelated processes:

• on the one hand, the company already operating in the industry seeks to expand your production and receive economies of scale in the long run (according to the LATC curve);
• on the other hand, external firms will begin to show interest in penetration into the industry(depending on the value of economic profit, the penetration process will proceed at different speeds).

The emergence of new firms in the industry and the expansion of the activities of old ones shifts the market supply curve to the right to the position S2(as shown in Fig. 9). The market price falls from P1 before R2, and the equilibrium volume of industry output will increase from Q1 before Q2. Under these conditions, the economic profit of a typical firm falls to zero ( P=SATC) and the process of attracting new companies to the industry is slowing down.

If for some reason (for example, the extreme attractiveness of initial profits and market prospects) a typical firm expands its production to the level q3, then the industry supply curve will shift even more to the right to the position S3, and the equilibrium price falls to the level P3, lower than min SATC. This will mean that firms will no longer be able to extract even normal profits and a gradual outflow of companies in more profitable areas of activity (as a rule, the least efficient ones leave).

The rest of the enterprises will try to reduce their costs by optimizing the size (i.e., by some reduction in the scale of production to q2) to a level at which SATC=LATC, and it is possible to obtain a normal profit.

Shifting the industry supply curve to the level Q2 cause the market price to rise to R2(equal to the minimum long-run average cost, P=min LAC). At a given price level, the typical firm earns no economic profit ( economic profit is zero, n=0), and is only able to extract normal profit. Consequently, the motivation for new firms to enter the industry disappears and the industry is long run equilibrium.

Consider what happens if the equilibrium in the industry is disturbed.

Let the market price ( R) has settled below the average long run cost of a typical firm, i.e. P. Under these conditions, the firm begins to incur losses. There is an outflow of firms from the industry, a shift in market supply to the left, and while maintaining market demand unchanged, the market price rises to the equilibrium level.

If the market price ( R) is set above the average long run costs of a typical firm, i.e. P>LATC, then the firm begins to earn a positive economic profit. New firms enter the industry, market supply shifts to the right, and with market demand unchanged, price falls to the equilibrium level.

Thus, the process of entry and exit of firms will continue until a long-term equilibrium is established. It should be noted that in practice, the regulatory forces of the market work better for expansion than for contraction. Economic profit and freedom to enter the market actively stimulate an increase in the volume of industry production. On the contrary, the process of squeezing firms out of an over-expanded and unprofitable industry takes time and is extremely painful for participating firms.

Basic conditions for long-run equilibrium

• Operating firms make the best use of the resources at their disposal. This means that each firm in the industry maximizes its profit in the short run by producing the optimal output at which MR=SMC, or since the market price is identical to marginal revenue, P=SMC.
• There are no incentives for other firms to enter the industry. The market forces of supply and demand are so strong that firms are unable to extract more than is necessary to keep them in the industry. those. economic profit is zero. This means that P=SATC.
• In the long run, firms in an industry cannot reduce total average costs and profit by scaling up production. This means that in order to earn a normal profit, a typical firm must produce a volume of output corresponding to a minimum of average long-term total costs, i.e. P=SATC=LATC.

In a long-term equilibrium, consumers pay the lowest economically possible price, i.e. the price required to cover all production costs.

Market supply in the long run

The individual firm's long-run supply curve coincides with the rising leg of the LMC above min LATC. However, the market (industry) supply curve in the long run (as opposed to the short run) cannot be obtained by horizontally summing the supply curves of individual firms, since the number of these firms varies. The shape of the market supply curve in the long run is determined by how resource prices change in the industry.

At the beginning of the section, we introduced the assumption that changes in industry output do not affect resource prices. In practice, there are three types of industries:

• with fixed costs
• with increasing costs
• with decreasing costs.

Industries with fixed costs

The market price will rise to P2. The optimal output of an individual firm will be equal to Q2. Under these conditions, all firms will be able to earn economic profits by inducing other firms to enter the industry. The industry short-run supply curve shifts to the right from S1 to S2. The entry of new firms into the industry and the expansion of industry output will not affect resource prices. The reason for this may lie in the abundance of resources, so that new firms will not be able to influence the prices of resources and increase the costs of existing firms. As a result, the typical firm's LATC curve will remain the same.

Rebalancing is achieved according to the following scheme: the entry of new firms into the industry causes the price to fall to P1; profits are gradually reduced to the level of normal profit. Thus, industry output increases (or decreases) following a change in market demand, but the supply price in the long run remains unchanged.

This means that a fixed cost industry is a horizontal line.

Industries with rising costs

If an increase in industry volume causes an increase in resource prices, then we are dealing with the second type of industries. The long-term equilibrium of such an industry is shown in Fig. 4.9 b.

A higher price allows firms to earn economic profits, which attracts new firms to the industry. The expansion of aggregate production necessitates an ever wider use of resources. As a result of competition between firms, resource prices increase, and as a result, the costs of all firms (both existing and new ones) in the industry increase. Graphically, this means an upward shift in the marginal and average cost curves of the typical firm from SMC1 to SMC2, from SATC1 to SATC2. The short run firm's supply curve also shifts to the right. The adjustment process will continue until economic profits dry up. On fig. 4.9 the new equilibrium point will be the price P2 at the intersection of the demand curves D2 and supply S2. At this price, the typical firm chooses the output at which

P2=MR2=SATC2=SMC2=LATC2.

The long run supply curve is obtained by connecting short run equilibrium points and has a positive slope.

Industries with diminishing costs

Analysis of the long-term equilibrium of industries with decreasing costs is carried out according to a similar scheme. Curves D1,S1 - the initial curves of market demand and supply in the short term. P1 is the initial equilibrium price. As before, each firm reaches equilibrium at the point q1, where the demand curve - AR-MR touches min SATC and min LATC. In the long run, market demand increases, i.e. the demand curve shifts to the right from D1 to D2. The market price rises to a level that allows firms to earn economic profits. New companies begin to flow into the industry, and the market supply curve shifts to the right. The expansion of production leads to lower prices for resources.

This is a rather rare situation in practice. An example is a young industry emerging in a relatively undeveloped area where the resource market is poorly organized, marketing is primitive, and the transportation system is poorly functioning. An increase in the number of firms can increase the overall efficiency of production, stimulate the development of transport and marketing systems, and reduce the overall costs of firms.

External savings

Due to the fact that an individual firm cannot control such processes, this kind of cost reduction is called foreign economy(English external economies). It is caused solely by the growth of the industry and by forces beyond the control of the individual firm. External economies should be distinguished from the already known internal economies of scale, achieved by increasing the scale of the firm and completely under its control.

Taking into account the factor of external savings, the function of the total costs of an individual firm can be written as follows:

TCi=f(qi,Q),

where qi- the volume of output of an individual firm;

Q is the output of the entire industry.

In industries with fixed costs, there are no external economies; the cost curves of individual firms do not depend on the output of the industry. In industries with increasing costs, there is negative external diseconomies, the cost curves of individual firms shift upwards with an increase in output. Finally, in industries with decreasing costs, there is a positive external economy that offsets internal uneconomics due to diminishing returns to scale, so that the cost curves of individual firms shift down as output increases.

Most economists agree that in the absence of technological progress, industries with increasing costs are most typical. Industries with diminishing costs are the least common. As industries with decreasing and fixed costs grow and mature, they are more likely to become industries with increasing costs. Against, technical progress can neutralize the rise in resource prices and even cause them to fall, resulting in a downward long-run supply curve. An example of an industry in which costs are reduced as a result of scientific and technical progress is the production of telephone services.

The considered behavior of firm is characteristic for the short-term period. However, the entrepreneur is interested not only in the immediate result, but also in the prospects for the development of the enterprise. Obviously, in the long run, the firm also proceeds from the problem of profit maximization.

The long run differs from the short run in that, firstly, the producer can increase production capacity (so all costs become variable) and, secondly, the number of firms in the market can change. In conditions of perfect competition, the entry and exit to the market of new firms is absolutely free. Therefore, in the long run, the level of profit becomes a regulator of attracting new capital and new firms to the industry.

If the established market price in the industry is above the minimum average cost, then the possibility of obtaining economic profit will serve as an incentive for new firms to enter the industry. As a result, the industry supply will increase (S → S1), and the price will decrease (Р > Р 1), as shown in Fig. 8.11. Conversely, if firms incur losses (at a price below the minimum average cost), this will lead to the closure of many of them and the outflow of capital from the industry. As a result, industry supply will decrease (S → S 2), which will increase the price (P → P 2 ).

The process of entry and exit of firms will stop only when there is no economic profit. A firm making zero profits has no incentive to exit, and other firms have no incentive to enter. There is no economic profit when the price is at the minimum average cost P = ATS typ. In this case we are talking about long run average cost LAC.

Long run average cost LAC (long average costs) are the costs of producing a unit of output in the long run. Every point LAC corresponds to a minimum of short-term unit costs ATS at any size of the enterprise (output volume). The nature of the long-term cost curve is associated with the concept of economies of scale, which describes the relationship between the scale of production and the magnitude of costs (the economies of scale discussed in the previous chapter). The minimum long-term costs determine optimal size enterprises. If the price is equal to the minimum long-run unit cost, the profit of the firm in the long run is zero.

Rice. 8.11. Changing the industry offer

Thus, the condition for the long-term equilibrium of the firm is the equality of the price to the minimum of long-term unit costs RE = = LAC min (Fig. 8.12).

Rice. 8.12. Long run equilibrium of the firm

Production at the lowest average cost means production with the most efficient combination of resources, i.e. firms make the best use of factors of production and technology. This is certainly a positive phenomenon, especially for the consumer. It means that the consumer receives the maximum amount of output at the lowest price that unit costs allow.

The firm's long run supply curve, like the short run supply curve, is part of the long run marginal cost curve. lmc, located above point E - the minimum of long-term unit costs LAC min. The industry supply curve is obtained by summing the long-run supply of individual firms. However, unlike in the short run, the number of firms can change in the long run.

So, in the long run, in a perfectly competitive market, the price of a good tends to a minimum of average costs, and this, in turn, means that when industry equilibrium is reached in the long run, the economic profit of each of the firms will be equal to zero.

At first glance, the correctness of this conclusion can be doubted: after all, individual firms can use unique factors of production, such as soils of increased fertility, highly qualified specialists, modern technology that allows them to produce products with less material and time.

Indeed, the costs of resources per unit of output for competing firms may differ, but the economic costs will be the same for them. The latter is explained by the fact that in conditions of perfect competition in the market of factors of production, the firm will be able to acquire a factor that has increased performance, if he pays for it a price that raises the costs of the firm to the general level in the industry. Otherwise, this factor will be outbid by a competitor.

If the firm already has unique resources, then the increased price should be accounted for as an opportunity cost, because at that price the resource could be sold.

What motivates firms to enter an industry if economic profits are zero in the long run? It all depends on the possibility of obtaining high short-term profits. To ensure this possibility by changing the situation of short-term equilibrium, the impact of external factors in particular the change in demand. An increase in demand will bring short-term economic profit. In the future, the action will develop according to the scenario already described above.

Consider the consequences of a change in demand, provided that resource prices remain unchanged (Fig. 8.13, a), resource prices increase (Fig. 8.13, b), resource prices decrease (Fig. 8.13, c).

Rice. 8.13. Industry supply in the long run

If, after reaching equilibrium (point E 1) industry demand will increase ( D1→D 2), then at first the price will rise from R 1 before P 2. At this price, firms will begin to receive economic profit, which will lead to an increase in supply in the industry both due to the expansion of production in individual firms and due to the arrival of new firms (this will be reflected in the figure by a shift S1 → S2). As a result, the price will again fall to the level Р 1 , since this value is equal to the minimum of LAC. The equilibrium in the industry will be established at the point E). If demand decreases (D2 > D1). then the price will decrease from R 1 before R 2 . At this price, firms will be at a loss, some of them will close and move to other industries. Market supply will decrease (S2 → S1). The sectoral equilibrium will be restored at the point E 1 (see Fig. 8.13, a).

Thus, perfect competition has a peculiar mechanism of self-regulation. Its essence lies in the fact that the industry responds flexibly to changes in demand. It attracts such a volume of resources that it increases or decreases supply just enough to compensate for changes in demand, and on this basis ensures the long-term break-even of firms operating in the industry.

If we connect two equilibrium points of the industry in the long run with various combinations of aggregate demand and aggregate supply (in Fig. 8.13, and these are the points E 1 and E2), then the supply line of the industry is formed in the long run - S1. Since we assumed that the prices of factors of production are unchanged, the line S1 runs parallel to the x-axis. This is not always the case. There are industries in which resource prices rise or fall.

Most industries use specific resources, the number of which is limited. Their application determines the upward nature of the costs in this industry. The entry of new firms will lead to an increase in demand for resources, the appearance of their deficit and, as a result, to a rise in price. For each new firm entering the market, scarce resources will cost more and more. Therefore, the industry will be able to produce more products only for more high price. This will cause the shift of the S1 curve (Fig. 8.13, b). Market equilibrium will be established at a new point E 2 .

Finally, there are industries in which, as the amount of resource used increases, its price decreases. The minimum average cost is also reduced in this case. Under such conditions, the growth of sectoral demand will cause in the long run not only an increase in the volume of supply, but also a decrease in the equilibrium price. Curve S1 will have a negative slope (Fig. 8.13, c). A new long-term equilibrium will be established at the point E 3 .

In any case, in the long run, the industry supply curve will be flatter than the short run supply curve. This is explained as follows. Firstly, the ability to use all resources in the long run allows you to more actively influence price changes, so for each individual firm, and therefore for the industry as a whole, the supply curve will be more elastic. Secondly, the possibility of "new" firms entering the industry and "old" firms leaving the industry allows the industry to respond to changes in the market price to a greater extent than in the short run.

Consequently, output will increase or decrease by a greater amount in the long run than in the short run in response to an increase or decrease in price. In addition, the industry's long-term supply price bottom is higher than the short-term supply chain bottom because all costs are variable and must be recovered.

So, in the long run, under conditions of perfect competition, the following will happen:

• a) the equilibrium price will be set at the level of the minimum long-run average cost R E = LAC min , what will ensure the long-term break-even of firms;
• b) the supply curve of a competitive industry is a line passing through the break-even points (minimum average costs) for each level of production;
• c) with a change in demand for the industry's products, the equilibrium price may remain unchanged, decrease or increase, depending on how the prices of production factors change. The industry supply curve will take the form of a horizontal straight line (parallel to the x-axis), an ascending or descending line.

The long-term period is understood as such a period of time when the firm changes the volumes of all the factors of production used.

Perfect competition implies the presence of a large number of firms, many buyers and sellers, the absence of price discrimination, when producers and buyers adapt to existing prices and act as price takers.

In its pure form, perfect competition is very rare.

Equilibrium position of a competitive firm in the long run (graph).

Under conditions of perfect competition in the long run, the following equality holds: MR=MC=AC=P (MR is marginal revenue; MC is marginal cost; AC is average total cost; P is price).

Perfect competition will help to allocate limited resources in such a way as to achieve maximum satisfaction of demand. This is provided under the condition that P=MS. This provision means that firms will produce the maximum possible amount of output until the marginal cost of the resource is equal to the price for which it was bought. This achieves not only high efficiency distribution of resources, but also maximum production efficiency. Perfect competition forces firms to produce products at the lowest average cost and sell it at a price corresponding to this cost. Graphically, this means that the average cost curve only touches the demand curve.

In the long run, firms have ample time to adjust in the best possible way to various market changes: whether to increase or decrease production, enter or leave an industry, and so on.

Three conditions for the equilibrium of the industry in the long run:

1) operating firms make the most efficient use of available capital equipment. This means that each firm in the industry in all short-term periods, which together form the long-term period, maximize profits by producing such a volume of output when MC = P

2) there are no incentives for firms in other industries to enter this industry. In other words, all firms in the industry have an output corresponding to the minimum of average total costs in each short run, and receive zero profit.

3) firms in the industry do not have the opportunity to reduce total costs per unit of output and make a profit by expanding the scale of production. This is equivalent to the condition under which each firm in the industry produces a volume of output corresponding to the minimum of average total costs in the long run.

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11.1 Perfect competition

We have already defined that the market is a set of rules, using which buyers and sellers can interact with each other and carry out transactions (transactions). Over the history of the development of economic relations between people, markets are constantly undergoing transformations. For example, 20 years ago there was no such abundance electronic markets that are available to the consumer now. Consumers couldn't buy the book, household appliances or shoes, simply by opening the website of the online store and making a few clicks with the mouse.

At the time when Adam Smith began to talk about the nature of markets, they were arranged something like this: most of the goods consumed in European economies were produced by a multitude of manufactories and artisans who used mainly manual labor. The firm was very limited in size, and employed only a few dozen workers at the most, and most often 3-4 workers. At the same time, there were quite a lot of such manufactories and artisans, and they were producers of fairly homogeneous goods. The variety of brands and types of products that we are used to in modern society there was no consumption then.

These signs led Smith to conclude that neither consumers nor producers have bargaining power, and the price is set freely by the interaction of thousands of buyers and sellers. Observing the features of the markets in the late 18th century, Smith came to the conclusion that buyers and sellers are guided towards equilibrium by an "invisible hand". The characteristics that were inherent in the markets at that time, Smith summarized in the term "perfect competition" .

A perfectly competitive market is a market with many small buyers and sellers selling a homogeneous product under conditions where buyers and sellers have the same information about the product and each other. We have already discussed the main conclusion of Smith's "invisible hand" hypothesis - a perfectly competitive market is able to provide an efficient allocation of resources (when a product is sold at prices that exactly reflect the firm's marginal cost of producing it).

Once upon a time, most markets really looked like perfect competition, but in the late 19th and early 20th centuries, when the world became industrial, and in a number of industrial sectors (coal mining, steel production, construction railways, banking) formed monopolies, it became clear that the model of perfect competition is no longer suitable for describing the real state of affairs.

Modern market structures are far from the characteristics of perfect competition, so perfect competition is currently an ideal economic model (like an ideal gas in physics), which is unattainable in reality due to the numerous forces of friction.

The ideal model of perfect competition has the following characteristics:

1. Many small and independent buyers and sellers unable to influence the market price
2. Free entry and exit of firms, i.e. no barriers
3. The market sells a homogeneous product that does not have qualitative differences
4. Product information is open and equally available to all market participants

Under these conditions, the market is able to allocate resources and goods efficiently. The criterion for the efficiency of a competitive market is the equality of prices and marginal costs.

Why does allocative efficiency arise when prices equal marginal cost and is lost when prices do not equal marginal cost? What is market efficiency and how is it achieved?

To answer this question, it suffices to consider simple model. Consider potato production in an economy of 100 farmers whose marginal cost of potato production is an increasing function. The 1st kilo of potatoes costs $1, the 2nd kilo of potatoes costs $2, and so on. None of the farmers has such differences in production function which would enable him to competitive advantage over the rest. In other words, none of the farmers have bargaining power. All potatoes sold by farmers can be sold at the same price, determined in the market for balances of general demand and total supply. Consider two farmers: farmer Ivan produces 10 kilograms of potatoes per day at a marginal cost of $10, and farmer Michael produces 20 kilograms at a marginal cost of $20.

If the market price is $15 per kilogram, then Ivan has an incentive to increase potato production because each additional product and kilogram sold earns him an increase in profits as long as his marginal cost does not exceed $15. For similar reasons, Mikhail has an incentive to reduction in production volumes.

Now imagine next situation: both Ivan and Mikhail, and other farmers initially produce 10 kilograms of potatoes, which they can sell at 15 rubles per kilogram. In this case, each of them has incentives to produce more potatoes, and the current situation will be attractive for the arrival of new farmers. Although each of the farmers has no influence on the market price, their joint efforts will lead to a fall in the market price to such a level until the opportunities for additional profit for each and every one are exhausted.

Thus, thanks to the competition of many players in conditions of complete information and a homogeneous product, the consumer receives the product at the lowest possible price - at a price that only breaks the marginal cost of the producer, but does not exceed them.

Now let's see how equilibrium is established in the perfectly competitive market in graphical models.

The equilibrium market price is established in the market as a result of the interaction of supply and demand. The firm accepts this market price as given. The firm knows that at this price it will be able to sell as many goods as it likes, so there is no point in lowering the price. If the firm raises the price of a product, it will not be able to sell anything at all. Under these conditions, the demand for the product of one firm becomes perfectly elastic:

The firm takes the market price as given, i.e. P = const.

Under these conditions, the firm's revenue schedule looks like a ray coming out of the origin:

Under perfect competition, a firm's marginal revenue is equal to its price.
MR=P

This is easy to prove:

MR = TR Q ′ = (P * Q) Q ′

Insofar as P = const, P can be taken out of the sign of the derivative. As a result, it turns out

MR = (P * Q) Q ′ = P * Q Q ′ = P * 1 = P

MR is the tangent of the slope of the straight line TR.

A perfectly competitive firm, like any firm in any market structure, maximizes total profit.

A necessary (but not sufficient condition) for maximizing the firm's profit is the zero derivative of profit.

R Q ′ = (TR-TC) Q ′ = TR Q ′ - TC Q ′ = MR - MC = 0

Or MR=MC

I.e MR=MC is another entry for the profit condition Q ′ = 0.

This condition is necessary but not sufficient for finding the maximum profit point.

At the point where the derivative is equal to zero, there may be a minimum of profit along with a maximum.

A sufficient condition for maximizing the firm's profit is to observe the neighborhood of the point where the derivative is equal to zero: to the left of this point, the derivative must be greater than zero, to the right of this point, the derivative must be less than zero. In this case, the derivative changes sign from plus to minus, and we get a maximum, not a minimum, of profit. If in this way we have found several local maxima, then to find the global profit maximum, you should simply compare them with each other and select the maximum profit value.

For perfect competition, the simplest case of profit maximization looks like this:

More complex cases of profit maximization will be discussed graphically in the appendix in the chapter.

11.1.2 The supply curve of a perfectly competitive firm

We realized that a necessary (but not sufficient) condition for maximizing the firm's profit is the equality P=MC.

This means that when MC is an increasing function, the firm will choose points on the MC curve to maximize profits.

But there are situations when it is beneficial for the firm to leave the industry, instead of producing at the point of maximum profit. This happens when the firm, being at the point of maximum profit, cannot cover its variable costs. In this, the firm incurs losses that exceed fixed costs.
The firm's optimal strategy is to exit the market, because in this case it receives losses exactly equal to fixed costs.

Thus, the firm will stay at the point of maximum profit, and not leave the market when its revenue exceeds variable costs, or, equivalently, when its price exceeds average variable costs. P>AVC

Let's look at the chart below:

Of the five marked points where P=MC, the firm will remain in the market only at points 2,3,4. At points 0 and 1, the firm will choose to leave the industry.

If we consider all possible options location of the line P, we will see that the firm will choose points lying on the marginal cost curve, which will be higher than AVC min.

Thus, the competitive firm's supply curve can be plotted as the portion of MC above AVC min.

This rule is applicable only for the case when the curves MC and AVC are parabolas. Consider the case where MC and AVC are straight lines. In this case, the total cost function is quadratic function: TC = aQ 2 + bQ + FC

Then

MC = TC Q ′ = (aQ 2 + bQ + FC) Q ′ = 2aQ + b

We get the following graph for MC and AVC:

As can be seen from the graph, when Q > 0, the MC graph always lies above the AVC graph (because the straight line MC has an angle of inclination 2a, and the straight line AVC slope angle a.

11.1.3 Short-run equilibrium of a perfectly competitive firm

Recall that in the short run, the firm necessarily has both variable and fixed factors. So, the costs of the firm consist of a variable and a fixed part:

TC = VC(Q) + FC

The firm's profit is p \u003d TR - TC \u003d P * Q - AC * Q \u003d Q (P - AC)

At the point Q* The firm achieves maximum profit because it P=MC (necessary condition), and the profit changes from increasing to decreasing (sufficient condition). On the graph, the profit of the firm is depicted as a shaded rectangle. The base of the rectangle is Q*, the height of the rectangle is (P-AC). The area of ​​the rectangle is Q * (P - AC) = p

That is, in this variant of equilibrium, the firm receives economic profit and continues to operate in the market. In this case P > AC at the point of optimal release Q*.

Consider the equilibrium where the firm earns zero economic profit

In this case, the price at the optimum point is equal to the average cost.

A firm can earn even negative economic profits and still continue to operate in the industry. This happens when, at the point of optimum, the price is lower than the average, but higher than the average variable costs. The firm, even receiving economic profit, covers the variable and part of the fixed costs. If the firm leaves, then it will bear all the fixed costs, so it continues to operate in the market.

Finally, the firm exits the industry when, at optimal output, its revenue does not even cover variable costs, that is, when P< AVC

Thus, we have seen that a competitive firm can earn positive, zero, or negative profits in the short run. The firm leaves the industry only when, at the point of optimal output, its revenue does not even cover variable costs.

11.1.4 Equilibrium of a competitive firm in the long run

The difference between the long run and the short run is that all factors of production for the firm are variable, that is, there are no fixed costs. Just as in the short run, firms can freely enter and exit the market.

Let us prove that in the long run the only stable state of the market is one in which the economic profit of each firm tends to zero.

Let's consider 2 cases.

Case 1 . The market price is such that firms earn a positive economic profit.

What will happen to the industry in the long run?

Since information is open and publicly available, and there are no market barriers, the presence of positive economic profits for firms will attract new firms to the industry. Entering the market, new firms shift market supply to the right, and the equilibrium market price falls to a level at which the opportunity for positive profits has not been completely exhausted.

Case 2 . The market price is such that firms earn negative economic profits.

In this case, everything will happen in the opposite direction: since firms earn negative economic profit, some firms will leave the industry, supply will decrease, the price will rise to a level at which the economic profit of firms will not become zero.