Long Run Equilibrium :
Long run equilibrium is defined as the time period during which all the factors of production can be varied and there are no fixed factors.
The firm in the long run can install a new plant or set up a new factory building. Long run is the period during which the size of the plant can be changed. So long run is variable plant period.
Equilibrium of the Firm in the Long – run:
A firm under perfect competition will be equilibrium in the long – run when it earns only normal profits.
The existence of free entry and free exit in perfect competition will ensure that the firm earns only normal profit in the long run.
Profits and losses earned in the short run provide a signal to the resource owners to enter or leave the industry.
If the existing firms are making abnormal (super normal) profits in the short run, new firms will tend to enter into the industry to earn these abnormal profits.
This will result in increase in total supply of the industry and hence the rightward shift of the supply curve of the industry. The rightward shift of the supply curve with an unchanged demand curve, will cause the equilibrium price to fall.
Fall in the equilibrium price will end up into fall in abnormal profits. This entry of the new firms will continue until increased supply has driven down market price to eliminate all abnormal profits and all the firms in the industry earn normal profits only.
Similarly, if the existing firms are incurring losses in the short run, this is a signal for the firms to exit from the industry in the long run.
As firms exit, the supply curve of the industry shifts to the left, resulting in the rise in the market price.
Firms will continue to exit and price will continue to rise until the remaining firms are covering all their cost means earning only normal profits.
Hence, in the long run, a firm under perfect competition can neither earn abnormal profit nor incur losses, it only earns normal profits.
Therefore, a perfectly competitive firm, in the long run, can be in equilibrium when it fulfil the two conditions:
1. Long run marginal cost (LMC) should be equal to marginal revenue (MR) i.e.,
LMC = MR
And LMC curve must cut the MU line from the below.
2. Average revenue (AR) should be equal to Long run Average Cost (LAC) so that the firm can earn normal profit.
AR = LAC
Since for perfectly competitive firm
AR = MR
Therefore, the long run profit maximisation formula would be
LMC = MR = AR = LAC
It means, full equilibrium implies the equality among all the four relevant variables, i.e., marginal cost, average cost, marginal revenue and average revenue.
All these four variables are equal at the point of tangency of the price line ( i.e. AR = MR = Price line) with AC curve at its minimum point.
The minimum point on the AC curve is the optimum point of production and the output produced at that point is the optimum output.
Therefore, long run equilibrium of the firm under perfect competition is only at the minimum point on its LAC curve, producing the optimum level of output.
Equilibrium of the Firm under Perfect Competition in the Long Run
The given figure illustrate the long run equilibrium of the firm.
- The U shaped LMC curve cuts the MR line from the below at point E, which is the equilibrium point also known as optimum point.
- The AR line ( MR = AR line) is tangent to the LAC curve at its minimum point which is point E.
- At point E, both the conditions of the long run equilibrium i.e., LMC = MR and AR = LAC are satisfied.
- It means at point E, the firm is earning only normal profits and the firm is just willing to stay in the industry.
Long – Run Equilibrium of the Industry:
An industry is in equilibrium in the long run when two conditions operate:
1. An industry is in equilibrium in the long run when its market demand equals to its market supply. Graphically, the point of intersection of demand and supply curves is the long run equilibrium point, where the price will remain unchanged.
2. The industry would be in equilibrium in the long run when it is neither expanding nor contracting.
The industry will expand and contract by the entry of new firms or the exit of some of the existing firms of the industry. This condition is possible only when the industry earns only normal profits. The industry would be in long run equilibrium when all the firms are producing at their minimum point of LAC curve and earning only normal profits.
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