Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed.

PART 5  Firm Behavior and the Organization of Industry

Chapter 14 of 36  Firms In Competitive Markets

Section 22 of 24

…

Figure 8 here

…

Figure 8 - An Increase in Demand in the Short Run and Long Run

Panel (a) initial condition

The market starts in a long-run equilibrium, point A.

In this equilibrium

· each firm makes zero profit

· the price equals the minimum average total cost (ATC)

…

Panel (b) short-run response

This shows what happens in the short run when demand rises from D1 to D2.

The equilibrium

· goes from point A to point B

· price rises from P1 to P2

· quantity sold in the market rises from Q1 to Q2

Because price now exceeds ATC firms make profits.

This encourages new firms to enter the market.

…

Panel (c) long-run response

This shows what happens in the long run after new firms enter the market.

· short-run supply curve shifts to the right from S1 to S2

· the equilibrium goes from point B to point C

· price has returned to P1

· the quantity sold has increased to Q3

· price is back to the minimum of ATC

· profits again are zero

· the market has more firms and greater supply to satisfy the greater demand

… …

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