Question

In the long-run equilibrium, all firms in a perfectly competitive market earn zero economic profit. Explain why this is true using intuition and graphs.

Answer 1

In the long-run equilibrium, all firms in a perfectly competitive market earn zero economic profit.

This is because of free entry and exit of firms in the long run

Left side case - when firms in a industry is earning super normal prodits in the short run

Then this will attract new firms to enter in the industry in the long run so there will be increase in aggregate supply which will lower down the prices

When prices lower than extra profits the firms are earning is reduced till it becomes to the level of normal profits where AR = AC

Right side case - when there is abnormal losses in the short run

This will make firms in the industry to leave in the long run so supply in the industry will reduce leading to rise in prices in the industry

Thus firms will start earning some profits

This will continue till normal profits are earned by firms