Question

What are the assumptions of perfect competition and what do they imply about the firms’s profits in the short and long run?

Answer 1

In the perfect competition, the following assumption are made-

-Firms are price takers-they cannot set their own price and must accept the market price

-Firms produce identical goods-the goods are perfect substitutes to one other

-Free entry and exit-the firms can enter or leave the market freely

In the short run, the firm will produce by setting P=MC and can make positive profits, breakeven or incur losses.

In the long run, the firms always end up earning normal profit or zero economic profit because of free entry and exit as more firms enter the market in case there is profit in short run or more firms firms leave the market in case there is loss which shifts the supply curve and either increase or decrease the price to the ATC level so that total revenue = total costs.