Long-run equilibrium

Definition

Long-run equilibrium refers to a state in an economic model where all economic forces are balanced, leading to a stable level of output and prices over time. In this condition, all firms in the market earn zero economic profit, which means that they cover all their costs, including opportunity costs, and no incentive exists for firms to enter or exit the market. This balance is crucial in understanding how markets operate and adjust over time, particularly in the context of cointegration, where long-term relationships among variables are examined.

5 Must Know Facts For Your Next Test

1. In long-run equilibrium, firms will adjust their production based on demand until economic profits are zero, meaning they just cover their costs.
2. The concept of long-run equilibrium is essential when analyzing the behavior of markets that experience fluctuations and eventual returns to stability.
3. Long-run equilibrium can shift due to changes in technology, preferences, or resource availability, which can affect supply and demand dynamics.
4. In the context of cointegration, if two or more time series are cointegrated, it suggests that they share a long-run relationship that maintains equilibrium despite short-term fluctuations.
5. The conditions for long-run equilibrium require that factors such as labor and capital are fully utilized and markets are efficient.

Review Questions

• How does long-run equilibrium relate to market dynamics and adjustments over time?
  • Long-run equilibrium signifies a point where all economic adjustments have been made, resulting in stable prices and outputs across the market. As firms respond to changes in demand or supply conditions, they adjust their production levels until they reach a point where they earn zero economic profits. This ongoing adjustment process highlights how markets work over time, ultimately leading to a balance where no firm has an incentive to enter or exit the market.
• Discuss the implications of long-run equilibrium in relation to cointegration and the analysis of economic time series.
  • In the context of cointegration, long-run equilibrium indicates that even if individual time series may wander due to random shocks, they exhibit a stable relationship over the long run. When two or more variables are cointegrated, it implies that they share an underlying connection that reflects long-term dynamics. This stability allows researchers to understand how these variables move together over time while accounting for short-term deviations.
• Evaluate the potential impact on long-run equilibrium if there is a significant technological advancement in an industry.
  • A significant technological advancement can disrupt the current long-run equilibrium by altering production processes, reducing costs, or improving efficiency. This innovation may lead to increased supply as firms adopt new technologies to enhance their output. As supply increases, prices might decrease initially; however, over time, firms will adjust their production levels and potentially re-establish a new long-run equilibrium at different levels of output and prices. The ability of firms to adapt to these changes will ultimately determine the new balance within the industry.

Related terms

Cointegration: Cointegration is a statistical property of a collection of time series variables that indicates a long-run equilibrium relationship among them, despite being non-stationary in their individual levels.

Economic Profit: Economic profit occurs when a firm's total revenues exceed its total costs, including both explicit and implicit costs, leading to above-normal returns.

Market Equilibrium: Market equilibrium is the point where the quantity supplied equals the quantity demanded at a given price, resulting in no tendency for price change.