Q+26a+Microeonomics

26a. Using suitable diagrams, explain why there is likely to be an absence of long run economic profits in perfect competition

It is important to remember that the long run is defined as the period in which firms are able to enter or exit the market. Moreover perfect competition is defined as a type of model that operates within five basic assumptions. There are a large number of firms competing in the market: a single firm is powerless to influence total market output and/or price – the firm is a price taker, the firms are producing homogeneous identical goods and there no barriers to entry or exit.

Because the firms are price takers they must adopt the same price that the market sets, in this case from the diagram the firm adopts a price of P. If the chooses to sell at a price higher than P the firm will not be able to sell any of its goods. However if the firm chooses to sell at a price lower than P then the firm will be selling its goods where its costs are higher than the revenue it would receive in return. If the demand in the market were to change, either shift left or right, the price of the goods in the industry and for the firm would change. As the price changes, the firm will either make economic profits or losses and will trigger either exit or entry in the long run. Exit or entry will thereby shift the industry supply curve left or right because firms are either exiting or entering the market. The supply curve would shift to a position where the new equilibrium price for the market and the firms is located at the minimum of the ATC curve thereby creating normal profit in the long run.