Short-run equilibrium

Definition

Short-run equilibrium refers to a market condition where the quantity of goods supplied equals the quantity of goods demanded at a specific price level, with at least one factor of production being fixed. In this state, firms may be earning profits or incurring losses, as they have not yet adjusted all inputs to reach a long-run sustainable level of output. This situation emphasizes the temporary nature of market dynamics, reflecting how businesses react to changes in demand and cost structures.

5 Must Know Facts For Your Next Test

1. In short-run equilibrium, firms may produce at a level where they can cover their variable costs but not necessarily their total costs, which can lead to losses if the situation persists.
2. The intersection of the short-run supply curve and the demand curve determines the equilibrium price and quantity in the market.
3. Firms will respond to short-run economic profits by increasing production, while losses may lead them to decrease output or exit the market in the long run.
4. Changes in consumer preferences or external factors can shift demand, causing the market to move away from short-run equilibrium until new adjustments are made.
5. While short-run equilibrium reflects immediate market conditions, it is not sustainable over the long term as firms adapt their production processes and enter or exit the market.

Review Questions

• How does short-run equilibrium differ from long-run equilibrium in terms of production adjustments and firm profitability?
  • Short-run equilibrium is characterized by firms responding to current demand with fixed factors of production, which may lead to profits or losses based on prevailing prices. In contrast, long-run equilibrium involves full adjustment where firms can modify all inputs and achieve normal profit levels. In the long run, firms cannot sustain losses as they exit or adjust their output to match demand better, leading to a more stable market condition.
• What role does marginal cost play in achieving short-run equilibrium for firms operating in competitive markets?
  • Marginal cost is essential for firms in determining their optimal level of production in short-run equilibrium. Firms will produce up to the point where marginal cost equals marginal revenue, which is where they maximize profits or minimize losses. If the price exceeds marginal cost, firms increase output; if it falls below, they reduce it. This decision-making process helps guide the market towards short-run equilibrium.
• Evaluate the implications of a sudden increase in demand on short-run equilibrium and its potential effects on market dynamics.
  • A sudden increase in demand shifts the demand curve to the right, leading to higher prices and quantities in short-run equilibrium. This change can result in positive economic profits for firms as they sell more at elevated prices. However, these profits may attract new entrants into the market over time, shifting supply until long-run equilibrium is achieved. Consequently, while immediate profits can benefit existing firms, the increased competition may eventually drive prices down again as supply adjusts.

Related terms

Price ceiling: A government-imposed limit on how high a price can be charged for a product, which can lead to shortages when set below the equilibrium price.

Market surplus: A situation that occurs when the quantity supplied exceeds the quantity demanded at a given price, often resulting from prices being set too high.

Marginal cost: The additional cost incurred by producing one more unit of a good or service, which plays a crucial role in determining short-run production decisions.