Question

Consider a perfectly competitive market that is currently in a short-run equilibrium, and where each firm in the market is making strictly positive profits. Each firm in the market is using a technology called the type A technology. Suppose that the type A technology is available in some finite number. Passed some threshold, new firms that would enter the market would have to use the type B technology, a different (and inferior) technology. The type B technology results in a higher long run average total cost curve than the type A technology. Given that the market exhibits positive profits in this short run equilibrium, new firms are going to enter the market. Claim: In the long run equilibrium, all firms in the market will be making zero economic profits. prove whether the claim that long run profits are 0 is true or false in this case. The use of graphs, whenever appropriate, is encouraged.

Answer 1

The claim that long run profits will be zero is true.

When the firms use B their AC increases as a result the firms start making losses. this will lead to few firms exiting the market at the existing price so the industry supply will decrease and supply will continue to shift to the left till the point

the equilibrium is hit at the point wherein the industry demand and new indurstry supply equalize at the price where there are normal profits.

It is a key feature of perfect cometition that due to the feature of free entry and exit of firms the industry will always stay at the point of normal profit because -

a) if there is super normal profit the new firms will enter, each firms market share will reduce and parallely increase in industry supply will bring down the price until forms are making normal profits

b) if there are losses, firms will exit the industry. thus the industry supply will fall and parallely each firm's market share will be more than earlier. The process will continue until price reaches the level at which there are normal profits