After you have worked through this section of the learning unit, you should be able to:
- describe the long-run equilibrium position
We have learnt that, in the short run, firms will be restricted in some way by the presence of fixed costs. However, in the long run, all factors of production and costs become variables, and firms are able to enter and exit the market. If firms in the market are making economic profits, this will attract new entrants into the market, whereas if firms are making economic losses, this will lead to firms exiting the market.
What condition of perfect competition allows firms to enter and exit?
- Many buyers and sellers
- Homogeneous goods
- Complete freedom of entry and exit
When existing firms are making an economic profit, it will attract new firms wishing to enter the market. As more firms enter the market, the market supply increases and the equilibrium price decreases. This process will continue until firms are only making a normal profit.
This can be illustrated by the following diagrams:
The market is represented in diagram A, while the individual firm is represented in diagram B.
Indicate whether the following statement relating to a competitive market is true or false:
If individual firms make an economic loss, it will result in existing firms exiting. The market supply thus decreases and the market supply curve shifts leftwards and the market price increases. This change in the market price causes the marginal revenue curve of the individual firm to shift upwards causing the economic loss of the firm to decline. This process continues until only a normal profit is made by the firm.
The above is illustrated in the following diagram: