Question

Explain using properly labelled diagrams, why a perfectly competitive firm will earn only normal profit in the long run

Answer 1

In perfect competition, entry and exit are free. In short run, if firms earn positive economic profit, new firms enter the market until each firm earns zero economic profit in long run, and if firms earn economic loss, firms exit the market until each firm earns zero economic loss in long run.

In the long run, for each firm, price equals ATC and the MC curve intersects ATC at the minimum point of ATC curve. In following graph, long run equilibrium is at point A where price (P0) intersects MC and ATC at the minimum point of ATC, with output Q0. Since Price equals ATC, economic profit is zero, signifying the firm is earning only normal profit.