“All the firms in a competitive industry achieve long run equilibrium when market price or marginal revenue equals marginal cost equals minimum of average total cost.”
Price = Marginal Cost = Minimum Average Total Cost
The long run is a period of time during which the firms are able to adjust their outputs according to the changing conditions. If the demand for a product increases, all the firms have sufficient time to expand their plant capacities, train and engage more labor, use more raw material, replace old machines, purchase new equipment, etc.
If the demand for a product declines, the firms reduce the number of workers on the pay roll, use less raw material. In short, all inputs used by a firm are variable in the long run. It is assumed that all the firms in the competitive industry are producing homogeneous product and an individual firm cannot affect the market price. It takes the market price as given. It is also assumed that all the firms in a competitive industry have identical cost’ curves. The industry it is assumed is, a constant cost industry. In the long run, it is for further assumed that all the firms in a competitive industry have access to the same technology.
When the period is long and profit level of the competitive industry is high, then new firms enter the industry. If the profit level is below the competitive level, the firm then leave the industry. When all the competitive firms earn normal profit, then there is no tendency for the new firms to enter or leave the industry. The firms are then in the long run equilibrium.
Diagram and Example:
The case of long-run equilibrium of a firm can be easily explained with the help of a diagram and example given below:
In the diagram (15.9), the firm is in the long run equilibrium at point K, where price or marginal revenue equals to long run marginal cost equals to minimum of long run average cost.
The average revenue per unit cost of the firm and its marginal revenue at price OP are the same. The firm at equilibrium point K, produces the best level of output OL and sells at price OP per unit. The total revenue of the firm is equal to the area OPKL.
The total cost of producing OL quantity of output is also equal to the area OPKL. The firm is earning only normal profits. At price OP, there is no tendency for the new firms to enter or leave the industry.
This can be proved by taking prices higher or lower price than OP. If the market price in the long run happens to be OR, the firm would be making more than normal profits. The new firms attracted by profit will enter the industry. The supply of the commodity will increase which derives the market price down to the OP level. The firm here makes only normal profits.
In case, a firm is faced with a market price OZ, the firm is then covering its full variable cost. As the firm is suffering a net loss at price OZ, it will leave the industry. So in the long run, price must be equal to OP which is the minimum average to cost of the firms.
At price OP, all the identical firms to the industry earn only normal profit. There is no tendency for the new firms to enter or leave the industry provided price equals to marginal revenue equals to marginal cost equals to minimum average total cost of the firms.
Price = MR = MC = Minimum of LATC
Long Run Industry Equilibrium:
Since all the competitive firms in the long run make normal profits, are of the optimum size and there is no tendency for the new firms to enter or leave the industry, they are, therefore, in equilibrium. When all the identical firms in the industry are in a state of full equilibrium equating price or marginal revenue, equating marginal cost equating minimum of average total cost, the industry itself is then in equilibrium.
When the industry is in the long run equilibrium, there is an optimum allocation of resources. The consumers get the products at the lowest possible price as, the goods are produced at minimum price in the long run.