Answer to Question #241333 in Microeconomics for Riffle

Question

With the help of well-labeled diagrams, compare the long run equilibrium of a firm under a perfectly competitive market structure and a monopoly market structure.

Answer 1

Long-Run Equilibrium in Perfect Competition

In the long run, companies that are engaged in a perfectly competitive market earn zero economic profits. The long-run equilibrium point for a perfectly competitive market occurs where the demand curve (price) intersects the marginal cost (MC) curve and the minimum point of the average cost (AC) curve.

In the long run, economic profit cannot be sustained. The arrival of new firms in the market causes the demand curve of each individual firm to shift downward, bringing down the price, the average revenue, and marginal revenue curve. In the long run, the firm will make zero economic profit. Its horizontal demand curve will touch its average total cost curve at its lowest point.

Long-run Equilibrium in Monopoly

In the long run, all the factors of production including the size of the plant are variable. A monopoly firm will maximize profit at that level of output for which long-run marginal cost (MC) is equal to marginal revenue (MR) and the LMC curve intersects the MR curve from below. In the figure, the monopoly firm is in equilibrium at point E where LMC = MR and LMC cuts the MR curve from below. QP is the equilibrium price and OQ is the equilibrium output.

At the OQ level of output, the cost per unit is QH (LAC), whereas the price per unit of the good is QP. HP represents the per unit supernormal profit. The total supernormal profit is equal to KPHN. It may here be noted that at the equilibrium output OQ, the plant is not being fully utilized. The long-run average cost (LAC) is not minimum at this level of output OQ. The firm will build an optimum scale of the plant only if the demand for the product increases.

When there is no threat of the entry of new firms into the industry, the monopoly firm makes long-run adjustments in the scale of the plant. In case, the demand for the product is limited, the monopolist can afford to produce output at a sub-optimum scale. If the market size is large and permits expansion of output, then the monopolist would build an optimum scale of plant and would produce goods at the minimum cost per unit. However, the monopolist would not stay in the business, if he makes losses in the long period.