Question

1. Explain how the long run differs from the short run in pure competition.

2. Explain how the entry and exit of firms affects resource flows and long-run profits and losses.

Answer 1

1. In the long run , entry and exit of firms in market can take place. In the short run, the industry is composed of fixed number of firms and each with fixed plant size and unalterable in the short run. Firms may shut down in the short run , if they were not able to cover variable costs and that they produce zero units of output in the short run . But they do not have time to liquidate their assets and go out of business.

In contrast, In the long run , the firms already in an industry have sufficient time to either expand or contract their capacities. The number of firms in an industry can either increases by entering of new firms or decreases by exit of existing firms.

2. Entry and exit of firms help to improve resource flows/allocation. Firms that exit an industry due to low profits , and release their resources to be used more profitably in other industries. Firms that enter an industry enjoying higher profits bring with them resources that were less profitably used in other industries. Either entering or exiting , both processes increase allocative efficiency.In the long run , market price of a product will equal to the minimum of average total cost of production. And as a result, all the profits are wiped off and in the long run , economic profits are zero.