Economics Online Tutor
Perfect Competition: Long
Long run equilibrium in perfect competition is reached when no economic
profits exist. Economic profits equal zero.
To understand this, remember that equilibrium is a situation in which no
incentives for change exist. Also remember that normal profits represent
an opportunity cost.
Normal profits are required in order to keep a firm from choosing a
different option than the current one.
If economic profits (profits above normal profits) exist, then the market
becomes more profitable than other markets or opportunities. With ease
of entry as a condition of perfect competition, this will be an incentive for
new firms to enter the industry.
If economic losses (profits less than normal profits) exist, then the market
becomes less profitable than other markets or opportunities. With ease of
exit, this becomes an incentive for existing firms to exit the industry.
Only when economic profits are equal to zero will no incentives for change
exist, allowing equilibrium to occur.
With ease of entry and exit a characteristic of perfect competition,
economic profits will cause new firms to enter the market. The market
supply curve will shift to the right, indicating an increase in supply. This
will create a new market price that is lower than the previous market price.
The lower market price will eliminate the economic profits, and equilibrium
can be reached.
Economic losses will cause existing firms to exit the market. The market
supply curve will shift to the left, indicating a decrease in supply. This will
create a new market price that is higher than the previous market price.
The higher market price will eliminate economic losses, and equilibrium
can be reached.
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