Question

• Respond to each short answer question using two to three well-constructed paragraphs (150 – 250 words) containing specific details and examples that support your understanding of the concepts.

1. In the long run, why do we expect that firms in perfect competition will earn zero economic profits?

Answer 1

In perfectly competitive market, there are a very large number of buyers and sellers hence each firm cannot influence the market price and the price for each firm is determined by the industry market forces of demand and supply. Firms are price takers in the market.

In the short run, existing firms can make economic profits by producing at a price greater than average total cost but any economic profits in a competitive environment leads to more firms trying to enter the market which shifts the supply to the right and puts pressure on price to fall till it reaches average total cost.

In the case where firms are producing below average total cost and making economic losses would lead to left shift in the supply curve and pressure on price to rise implies back to market price equal to average total cost in the long run.

Hence zero profits in the long run at P= LRAC