ArtsAutosBooksBusinessEducationEntertainmentFamilyFashionFoodGamesGenderHealthHolidaysHomeHubPagesPersonal FinancePetsPoliticsReligionSportsTechnologyTravel
  • »
  • Education and Science»
  • Economics

The Long-Run Period and Secular Period Price Determination Under Perfect Competition

Updated on June 1, 2014

The Long-Run Period Price Determination

“Long-run” period is a period of many years. Long period is the time during which the supply conditions are fully able to meet the new demand conditions. In the long-run both fixed as well as variable factors are variable. In this period, new plants can be installed and new firms can enter into the market and the old firms can leave the market. Long period price is called by Adam Smith as “natural price” and Marshall called it as ‘normal price’. According to Marshall, “The normal value or price of a commodity is that which economic forces would tend to bring about in the long-run.”

However, in reality long-run or normal price may never be actually achieved. This is because, in the long period even before the supply adjusts itself to demand, some disturbance, in demand or supply may take place, thereby causing disequilibrium. The normal price, like ‘tomorrow’, never comes.

The following diagram illustrates the determination of the price in the long period:

MPSC = Market period supply curve

SPSC = Short period supply curve

LPSC = Long period supply curve

DD = Initial demand curve

D1D1 = Increased demand curve

The original market price is OP. As a result of an increase in demand the price has moved from OP to OP1 in the very short period. The supply curve in the short-run normal period is SPSC. In the short period, the price falls from OP to OP2 because the supply can be increased to some extent. The long-run supply curve is LPSC. In the long period price further falls to the level of OP3 because supply can adjust fully to the demand.

Long-Run Normal Price in constant Cost Industry

In the case of a constant cost industry, the cost of production remains constant even as the production level is changed. To put it in other words, the emergence of external economies is equally counter balanced by diseconomies as production expands, and so the cost of production remains the same. Since larger quantities of the commodity can be produced at the same cost, the supply curve will be parallel to the X-axis.

In the words of Stigler, “…a constant cost industry is usually defined as one whose supply price is the same for all outputs and also is one in which the prices of outputs do not vary with input.”

The pricing process is illustrated in figure 2 given below:

The market period supply curve MPSC intersects the demand curve DD and the price is OP. D1D1 is the increased demand curve. Since the supply is inelastic the price moves from OP to OP1. The price OP1 is higher than OP and so the existing firms will be making abnormal profits. As a result, new firms will enter into the industry and produce more. Since a constant cost condition is assumed, the long period supply curve will be parallel to the X-axis cutting the new increased demand curve. The long-run normal price is OP, which is equal to the original price. The output has increased from OM to OM2.

Long-Run Normal Price in an Increasing Cost Industry

The supply curve of an increasing cost industry will slope upwards from left to right showing that an increased output will be available at an increased cost and, therefore at an increased price. Increasing costs are the most typical of the actual competitive world conditions. In this industry, external diseconomies tend to outweigh external economies. Increase in the costs of production shifts the LAC and LMC upwards for all the firms. In the long-run price is always equal to the minimum average cost. So price increase also will equal to the minimum LAC. This pricing is explained in the following figure.

MPSC = Market period supply curve

LPSC = Long period supply curve

SPSC = Short period supply curve

To begin with, DD is the demand curve and MPSC is the short period supply curve. OP is the market price. D1D1 is the increased demand curve. The price is OP1, which is higher than OP.

In the short period, the existing firms will increase the supply, and the increased demand curve D1D1 intersects the short period supply curve at E2. Consequently, the market price falls from OP1 to OP2. In this situation, the existing firms will make extra profits. As a result, new firms will enter the industry and start producing more. The cost curves will go up higher and higher as the industry is working under increased cost conditions. The output of the industry increases from OM to OM2 because of the entry of new firms. Price in the long-run will fall to OP3 at which the demand curve D1D1 intersects the LPSC. Thus, OP3 is the long-run normal price.

This long-run normal price OP3 must be equal to the minimum long-run average cost. New firms will continue entering the industry until all the firms earn only normal profits. However, this minimum average cost is higher than the initial minimum cost because costs have risen due to the entry of new firms. The new normal price OP3 is higher than the original normal price OP.

Long-Run Normal Price in a Decreasing Cost Industry

In the case of a decreasing cost industry, the external economies may be more than external diseconomies because of which the cost of production tends to decrease. The normal price will be lower than the market price. The LPSC slopes downwards, from left to right, showing that as output increases per unit cost decreases.

The initial equilibrium point is E where the price is OP and the output OM. With the increase in demand from DD to D1D1 the market price rises to OP1. In the short-run, when the supply increases from OM to OM1 the price falls from OP1 to OP2. In the long-run new firms will enter the industry and cause a downward shift in the demand curves of all the firms. When the supply increases further to OM2, in the long-run, the price also falls to OP3. This long-run price OP3 is less than the original market price OP. the above features of an industry can be summarized as follows:

Table 1

Nature of Industry
Price
Reason
Constant Cost
Market Price = Long-Run Normal Price
Operation of Constant Returns
Increasing Cost
Long-Run Normal Price > Market Price
Operation of Diminishing Returns
Decreasing Cost
Long-Run Market Price < Market Price
Operation of Increasing Returns

Secular Period

The secular period is very long period. The secular period ranges beyond a generation, more than 33 years. During this period, all underlying factors, which affect demand such as the size of population, techniques of production, supplies of raw materials etc. have time to alter. Since the period is too long, Marshall does not analyze pricing under the secular period. He treats secular price as a kind of normal price, and as a historical category.

Comments

    0 of 8192 characters used
    Post Comment

    No comments yet.