Long-Run Adjustment

Long-Run Adjustment

• Firm Adjustment: Each firm in the perfectly competitive industry adjustments short-run production and long-run plant size to achieve profit maximization. This adjustment entails producing the quantity that equates price (and marginal revenue',500,400)">marginal revenue) to short run marginal cost for a given plant size as well as selecting the plant size that equates price (and marginal revenue) to long-run marginal cost.


• Industry Adjustment: Firms enter and exit a perfectly competitive industry in response to economic profit and loss. If firms in the industry earn above-normal profit, or receive economic profit, then other firms are induced to enter. If firms in the industry receive below-normal profit, or incur economic loss, then existing firms are induced to exit. The entry and exit of firms causes the market price to change, which eliminates economic profit and loss, and leads to exactly normal profit.

P = AR = MR = MC = LRMC = ATC = LRAC

Long-Run Industry Supply Curve

The path taken by an industry depends on underlying changes in resource prices and production cost. If the expansion of an industry causes higher resource prices and production cost, then the result is an increasing-cost industry. If expansion causes lower resource prices and production cost, then the result is a decreasing-cost industry. If expansion has no affect on resource prices and production cost, then the result is a constant-cost industry.

The Zucchini Market

This exhibit illustrates the hypothetical Shady Valley zucchini market, which is shocked by an increase in demand. The original market equilibrium, with the supply curve S and the demand curve D, is equilibrium price Pe and equilibrium quantity Qe. The increase in demand causes the equilibrium price of zucchinis increases to Pe' and the equilibrium quantity rises to Qe'. The higher price and larger quantity is achieved as each existing firm in the industry responds to the demand shock.

However, the higher price leads to above-normal economic profit for existing firms. And with freedom of entry and exit, economic profit attracts kumquat, cucumber, and carrot producers into this zucchini industry. An increase in the number of firms in the zucchini industry then causes the market supply curve to shift. How far this curve shifts and where it intersects the new demand curve, D', determines if the zucchini market is an increasing-cost, decreasing-cost, of constant-cost industry.

The three alternatives are:

• Increasing-Cost Industry: An industry with a positively-sloped long-run industry supply curve that results because expansion of the industry causes higher production cost and resource prices. An increasing-cost industry occurs because the entry of new firms, prompted by an increase in demand, causes the long-run average supply curve of each firm to shift upward, which increases the minimum efficient scale of production. Click the [Increasing-Cost] button to illustrate.


• Decreasing-Cost Industry: An industry with a negatively-sloped long-run industry supply curve that results because expansion of the industry causes lower production cost and resource prices. A decreasing-cost industry occurs because the entry of new firms, prompted by an increase in demand, causes the long-run average cost curve of each firm to shift downward, which decreases the minimum efficient scale of production. Click the [Decreasing-Cost] button to illustrate.


• Constant-Cost Industry: An industry with a horizontal long-run industry supply curve that results because expansion of the industry causes no change in production cost or resource prices. A constant-cost industry occurs because the entry of new firms, prompted by an increase in demand, does not affect the long-run average cost curve of individual firms, which means the minimum efficient scale of production does not change. Click the [Constant-Cost] button to illustrate.