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Home Price and Output Determination Under Perfect Competition Long Run Normal Price and the Adjustment of Market Price to the Long Run Normal Price

 

Long Run Normal Price and the Adjustment of Market Price to the Long Run Normal Price:

 

Definition and Explanation:

When we speak of a long period, we do not mean an interval of time in which we all may be dead. By long run is meant the period in which the factors of production can be adjusted to changes in demand. The long run period differs with different industries. In some industries, the preparation of the plan, the expansion, construction of the new building, installation of new machinery, training of new labor may take only a few months and in others, it may take a few years.

In the long run, the price will be determined at a point where the demand curve and the long run supply curve intersect each other. The shape of the long run supply curve will, however, be different with different industries. If the industry is subject to increasing cost, the long run supply curve will slant upward from left to right. If the industry is subject to diminishing cost, it will fall downward from left to right. If the industry is subject to constant cost, it will be parallel to the quantity axis.

Let us examine now the determination of long run price under the above three conditions and also see as to how the market price adjusts itself for the long run normal price.

Dynamic Changes and Industry Equilibrium:

(1) Increasing Cost Industry and Long Period Price Determination:

The long run supply curve in increasing cost industry slants upward from left to right but the rise is less steep as compared to short period supply curve. The market price is determined at a point where the long run supply curve cuts the demand curve as is illustrated below.

Diagram:

In this fig. 15.16 market supply curve (MSC), short period supply curve (SPC), long period supply curve (LPSC), pass through the point P. The market price, short period price and the long run normal price thus is equal to ON.

Let us suppose that there is once for all increase in the market demand. The new demand curve D1 D1 intersects the market supply cure, short, period supply curve, and long period supply curve (LPSC) at points Z, R, A, respectively. The new market price with be equal to OD, the short period price equal to OC and long period price equal to OE.

 

The market price OD is higher than short period normal price and long run normal price. The short period normal price OC is lower than the market price but higher than long run normal price. The long run normal price OE is the lowest of the two but is higher than the original market price ON. How much the long run price will differ from the market price depends upon the supply condition in a particular industry. The fact in that the market price oscillates round the long run normal price.

 

(2) Decreasing Cost Industry:

 

In case of decreasing cost industry, the long run supply curve will have a negative slope. The price will be determined at a point where the market demand curve intersects the long period supply curve as shown below.

 

Diagram:

 

 

In Fig. (15.17) market supply curve, long period supply curve and demand curve intersect at point P. ON is the original market price. If demand rises, the new demand curve D1D1 intersects the market supply, curve at point E and long run supply curve at point R. OQ then will be the new market price and so the long run normal price. The long run normal price OS is now lower than the original market price ON. The market supply increases from OK to OT in the long run.     

 

(3) Constant Cost Industry:

 

If the industry is subject to constant cost, the long run supply curve will be a horizontal straight line parallel to the base axis.

 

Diagram:

 

 

In Fig. 15.18 long period supply curve, market supply curve and the market demand curve pass through point E, ON is thus the original! market price. If demand rises, the new market price will be higher than the original market price. It is OS in the diagram. In the long run, however, the price falls to ON because the long period supply curve is a horizontal straight line. The quantity supplied increases from OM to OK.

 

We, therefore, conclude by saying that the long run normal price will be higher than, lower than or remains equal to the original market price depending open the additional supply which can be acquired according to the changed conditions in the long run.

Relevant Articles:

Market Structure
Perfect Competition
Equilibrium of the Firm
Short Run Equilibrium of the Price Taker Firm
Short Run Supply Curve of a Price Taker Firm
Short Run Supply Curve of the Industry
Long Run Equilibrium of the Price Taker Firm
Long Run Supply Curve For the Industry
Price Determination Under Perfect Competition
Market Price
Determination of Short Run Normal Price
Long Run Normal Price and the Adjustment of Market Price to the Long Run Normal Price
Distinction/Difference Between Market Price and Normal Price
Interdependent Prices
Joint Supply
Fixation of Railway Rates

Composite or Rival Demand

 

Principles and Theories of Micro Economics
Definition and Explanation of Economics
Theory of Consumer Behavior
Indifference Curve Analysis of Consumer's Equilibrium
Theory of Demand
Theory of Supply
Elasticity of Demand
Elasticity of Supply
Equilibrium of Demand and Supply
Economic Resources
Scale of Production
Laws of Returns
Production Function
Cost Analysis
Various Revenue Concepts
Price and output Determination Under Perfect Competition
Price and Output Determination Under Monopoly
Price and Output Determination Under Monopolistic/Imperfect Competition
Theory of Factor Pricing OR Theory of Distribution
Rent
Wages
Interest
Profits
Principles and Theories of Macro Economics
National Income and Its Measurement
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Fiscal Policy
Determinants of the Level of National Income and Employment
Determination of National Income
Theories of Employment
Theory of International Trade
Balance of Payments
Commercial Policy
Development and Planning Economics
Introduction to Development Economics
Features of Developing Countries
Economic Development and Economic Growth
Theories of Under Development
Theories of Economic Growth
Agriculture and Economic Development
Monetary Economics and Public Finance

History of Money
 

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