**Theory**: A situation is a long run equilibrium if

- no firm in the industry wants to leave
- no potential firm wants to enter.

**Implications**: Given the definition of economic profit, the theory implies that in a long run equilibrium

- no existing firm makes a loss
- any potential firm that entered would make a loss

Assuming that the technology (and hence cost functions) of every firm are the same, and ignoring the discrete change that may occur in the firms' maximal profits when a firm enters, the theory thus implies that

or, equivalently,in a long run equilibrium every firm'smaximalprofit is zero

price is equal to minimum average cost.

Given this terminology, another implicaton of the theory is:

What determines the equilibrium number of firms? Given the equilibrium price (minimum average cost), the aggregate demand functionevery firm produces at the efficient scale of production.

Some terminology:

- if TC
_{Y}(*y*) is independent of*Y*the industry is a**constant cost industry**. - if TC
_{Y}(*y*) is increasing in*Y*for all value of*y*the industry is an**increasing cost industry**. - if TC
_{Y}(*y*) is decreasing in*Y*for all value of*y*the industry is an**decreasing cost industry**.

The **long run competitive equilibrium** when every firm's long run average cost curve is the same, given by LAC_{Y}, is characterized by a price *p**, an output *y** for each firm, and a number *n** of firms such that

These conditions are interrelated: the variablesp* is the minimum of LAC_{n*y*}

y* is the minimizer of LAC_{n*y*}

Q_{d}(p*) =n*y*.

In the case of a *constant cost industry*, in which LAC is independent of industry output, the three conditions reduce to

These conditions have a very simple structure: the first one determinesp* is the minimum of LAC

y* is the minimizer of LAC

Q_{d}(p*) =n*y*.

Given how the short run and long run cost curves are related, note that in a long run equilibrium we have:

where SACp* = LAC_{Y}(y*) = SAC_{Y,y*}(y*) = LMC_{Y}(y*) = SMC_{Y,y*}(y*),

We can tell a dynamic story when the demand shifts. If it shifts to the right, for example,

- in the short run each firm produces more, and makes profit
- then more firms enter
- the short run supply (given the number of firms) therefore moves out
- the price falls, and each firm reduces its output again.

Again we can tell a dynamic story: Initially each of *n*_{1}* firms produces *y** and the price is *p*_{1}*. Suppose demand increases from *D*_{1} to *D*_{2}.

- in the short run price rises, as each firm expands and moves up its short run supply function
- the profit induces more firms to enter
- input prices rise as the demand for inputs increases, so LAC rises
- in the new long run equilibrium there are
*n*_{2}* firms, each producing*y** as before.

Copyright © 1997 by Martin J. Osborne