Microeconomics - Effects on Equilibrium in the Short and Long Run

The Firm vs. the Industry's Short-Run Supply Curve
A company will continue to produce output until marginal revenue (MR) is equal to marginal cost (MC).

In other words, the condition for maximum profit occurs where:
MR = MC

Another condition for profit to be maximized, because it is possible that MR=MC at a point where MC is falling, is that the marginal cost curve must be rising. Therefore, the supply curve for a competitive firm will be that part of the marginal cost curve which lies above the low point of the average cost curve. The supply curve slopes upward because marginal costs increase with the greater quantity supplied in the short run. With a competitive market, the supply curve will be a summation of the individual firms' supply curves.

Long-Run Effects on Equilibrium
In the short-run, increases (decreases) in demand in a competitive market will cause prices and output to increase (decrease).

In the long-run, increases (decreases) in demand in a competitive market will cause increases (decreases) in output. Initially, markets with an increase (decrease) in demand will have firms experiencing economic profits (losses). Over time, markets with firms experiencing economic profits (losses) will have additional firms enter (existing firms will exit) the market, and prices will decrease (increase) towards previous levels. If cost conditions remain the same, then prices will revert to what they were before the increase (decrease) in demand.

If the market price falls below a firm's average total cost, the firm will incur economic losses. The firm may be able to lower its average total cost by changing to a different plant size. Suppose a firm increases its plant size, and lowers its average total costs. If other firms follow, then the industry supply curve will shift to the right. This will result in lower prices and less economic profit.

If a firm does not expect market conditions to improve then it may decide to go out of business. This would be the preferred option as, by selling out, neither fixed nor variable costs would be incurred.

Impact From Changes in Technology
The impact of a permanent change of demand on price and output for a market will be influenced by the cost structure of suppliers in the market. The long-run market supply curve in a competitive industry will depend on the returns to scale.

For a constant-cost industry, if demand increases, then firms temporarily will make a profit as price will go above the minimum needed for the firms to stay in business. This will cause firms to expand output or new firms to enter the industry. Because costs are constant in the long run, the long-run supply curve will be horizontal. In the graph below, as demand shifts from D1 to D2, over the long run quantity will increase from Q1 to Q2. However, price will remain the same.

Figure 3.12: Long Run Supply: Constant Cost Industry

For an increasing cost industry, if demand increases, firms will need higher prices over the long run in order to justify higher levels of production. For example, prices for raw materials used in the industry may go up with higher levels of production, which will force the long-run supply curve to slope upward.

Figure 3.10: Long Run Supply: Increasing Cost Industry

For a decreasing cost industry, if demand increases, in the long run firms can provide more output at lower prices. The need to produce larger quantities of goods and services in response to increased demand induces technological change, which lowers costs for the producer and these savings are passed on to consumers in the long run.

Figure 3.11: Long Run Supply: Decreasing Cost Industry

Characteristics of Monopolies


Related Articles
  1. Term

    What Is Equilibrium?

    Equilibrium is a state of balanced supply and demand.
  2. Bonds & Fixed Income

    Yield Curve

    Learn more about how this curve is used to predict changes in economic output and growth.
  3. Economics

    Introduction To Supply And Demand

    Find out all about supply and demand and how it relates to your daily purchases.
  4. Economics

    What is Deadweight Loss?

    Deadweight loss can be applied to any deficiency caused by an inefficient allocation of resources.
  5. Economics

    Law of Supply

    The law of supply is one of the most fundamental principles in microeconomics. According to the law of supply, for all other things remaining constant, the higher the price of a good or service, ...
  6. Economics

    Law of Demand

    The law of demand is one of the most fundamental principles in microeconomics. It's all about how price affects demand. According to the law of demand, for all other things remaining constant, ...
  7. Investing

    Trade Bond ETFs Using Yield Curves

    Different types of yield curves provide important insights for trading bond-based securities.
  8. Economics

    What Does Long Run Mean?

    A long run is a period of time in which all factors of a business’ production and costs are variable.
  9. Active Trading

    Why You Can't Influence Gas Prices

    Don't believe the water-cooler talk. Big oil companies aren't to blame for high prices.
  10. Economics

    Defining Cost-Push Inflation

    Cost-push inflation is caused by an increase in the cost of production, due to higher prices for raw materials or labor.
RELATED TERMS
  1. Equilibrium Quantity

    The quantity of an item that will be demanded at the point of ...
  2. Change In Supply

    A term used in economics to describe when the suppliers of a ...
  3. Demand

    An economic principle that describes a consumer's desire and ...
  4. Supply

    A fundamental economic concept that describes the total amount ...
  5. Supply Curve

    The supply curve is a graphical representation of the relationship ...
  6. Law Of Supply

    A microeconomic law stating that, all other factors being equal, ...
RELATED FAQS
  1. Why are microeconomic models different in the short run than the long run

    Find out why short-run and long-run microeconomic models treat production, costs and variable change using different given ... Read Answer >>
  2. Is demand or supply more important to the economy?

    Learn more about the impact of supply and demand in an economy. Find out why companies study supply and demand as part of ... Read Answer >>
  3. Do production costs include all fixed and variable costs?

    Learn more about fixed and variable costs and how they affect production costs. Understanding how to graph these costs can ... Read Answer >>
  4. Why is time an important factor when evaluating supply?

    Learn how suppliers respond to increases in demand and why time is an important factor in supply and demand. Find out how ... Read Answer >>
  5. How does the law of supply and demand affect prices?

    Learn what the law of supply and demand is, what relationship it has with prices, and how the law of supply and demand affects ... Read Answer >>
  6. How can the yield curve help me make investment decisions?

    Learn about the yield curve, and discover why this chart is an important economic indicator. How do Treasury bond yields ... Read Answer >>
Hot Definitions
  1. Reverse Mortgage

    A type of mortgage in which a homeowner can borrow money against the value of his or her home. No repayment of the mortgage ...
  2. Labor Market

    The labor market refers to the supply and demand for labor, in which employees provide the supply and employers the demand. ...
  3. Demand Curve

    The demand curve is a graphical representation of the relationship between the price of a good or service and the quantity ...
  4. Goldilocks Economy

    An economy that is not so hot that it causes inflation, and not so cold that it causes a recession. This term is used to ...
  5. White Squire

    Very similar to a "white knight", but instead of purchasing a majority interest, the squire purchases a lesser interest in ...
  6. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
Trading Center