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  Long run equilibrium

Long run equilibrium, price and output determination:

In long run, each factor is variable. The firms can raise their output by rising the number and plant size of the firms. Furthermore, new firms can enter the organization and the existing firms can leave the industry. Since an outcome, all existing firms will just earn normal profit in the long run.

When the existing firms earn supernormal gain, the new firms will enter the industry to battle with the existing firms. As an outcome, the output generated will raise. Whenever the total output raises, the demand for factors of production will rises leading to increase in costs of the factors. These will outcome in increase in average cost.

On other side, whenever the output produced raises, the supply of the product also increases. The demand remains similar, whenever the supply of the product raises, the price of the product comes down. Therefore the average revenue will come downward. The fall in average revenue and the increase in average cost will continue till both become equivalent. (i.e., AR =AC). Therefore, all the perfectly competitive firms will earn normal gain in the long run.

Figure below symbolizes long run equilibrium of firm beneath perfect competition. The firm is in equilibrium at point S where LMC = MR = AR = LAC. The long run equilibrium yield is ON. The firm is earning only the normal earnings. The equilibrium price is OP. When the price rises above OP, the firm will earn abnormal earnings that will attract latest firms into the industry. When the price is less than OP, there will be loss and the tendency will be to way out. Therefore in the long run equilibrium, OP will be the price and marginal cost will be equivalent to the average cost and average revenue. Therefore the firm in the long run will earn only normal gain. Competitive firms are in balance at the minimum point of LAC curve. Executing at minimum point of LAC curve indicates that the firm is of optimum size that is, generating output at the lowest possible average cost.

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Figure: Long run equilibrium of the firm

 

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