Question

Explain why in the long run, perfectly competitive firms will make no profit. What is the long run equilibrium condition for a firm? ( first assume firm are making positive profits and then assume some firms are making negative profits... graphs).

Answer 1

In a perfectly competitive market inlong-run equilibrium, an increase in demand creates economic profit in the short run and induces entry in the long run; a reduction in demand creates economic losses in the short run and forces some firms to exit the industry in the long run .

The condi­tion for long-run equilibrium of the firm can be written as:

Price = Marginal Cost = Minimum Average Cost.

Fig. represents long-run equilibrium of firm under perfect compe­tition. The firm cannot be in the long-run equilibrium at a price greater than OP in Fig. This is be­cause if price is greater than OP, then the price line (demand curve) would lie somewhere above the minimum point of the av­erage cost curve so that marginal cost and price will be equal where the firm is earning abnormal profits.