Question

Diagram a model of a perfectly competitive market and a separate model of a firm experiencing economic profits. Explain and illustrate on your models the changes that take place in the long run. Be sure to explain why any changes take place.

Answer 1

A perfectly competitive market diagram in equilibrium looks like below.

The labelling in the diagram has usual meanings.

Here we can see that there is zero economic profits occuring in the market. But zero economic is occuring to each and every firm in the market is not necessarily true in the short run. In the short run some firms may be experiencing economc profits or even losses. But in the long run each and every firm will experiece zero economic profits and will have diagram similar to the diagram as shown above for market.

Now,

A firm in competitive market with economic profits (in short run) will have curve like below

Here in above diagram the yellow shaded portion i.e. area of rectanglr PCBA is the amount of economic profits earned by a firm.Note that here price is higher than the minimum point on AC curve (i.e. where MC curve intersects AC curve from below). in the case of market price curve ( or AR and MR curve) was exactly coinciding with the lowest point on AC curve. thus there was no economic profits.

In the long run however each firm will however experience no economic profits and the graph will look similar to the graph of market.

the long run curve for a competitive firm n would be like.

(Note that in above diagram quantity of firm n is denoted by Qn while in first diagram (i.e. of market) the quantity produced by market was represented by Q).