Sunday, April 4, 2010

Change in Demand in a Perfectly Competitive Market

In a competitive market the firms are are not making any economic profit and the entreprenuer makes normal profit. It is part of a long-run equilibrium. With that said, the demand increases which causes prices to rise and firms will have to increase proudction in order to be able to maintain the marginal cost equal to the price, and the firm will make economic profit. In this process, the market becomes part of short-run equilibrium.

The economic profit is what interests a firm to participate in a market. As the number of firms enter into a market, the market supply increases and the prices will start to decrease. With lower prices, firms' output decreases in order to maintain the marginal cost equal to the price.

There are two different types of equilibriums associated with this: Initial long-run competition and new long-run equilibrium. The difference between the two is the permanant increase in demand in the number of firms. Every firm produces the same amount of output in the new long-run equilibrium as at first and does not make any economic profit.

A decrease in demand causes a lower price, ecnomic loss, and exit from the market. The exit from the market will decrease the market supply, cause an increase in prices, and will eradicate economic loss.

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