Explain in detail why in Pure Competition firms will always break even, use the economic profit...

Explain in detail why in Pure Competition firms will always break even, use the economic profit and shut down situation to explain why firms will break even. Please include the graphs to explain these concepts.

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Expert Solution

In the short run, a perfectly competitive firm produces where its P=MC and its P=AR=MR

When the P>SAC the firms will make profits and when the P<SAC the firm will make losses as shown below.In the first graph, the firm is incurring losses but still continue to produce at the price is more than its shutdown point which is the minimum point on the AVC curve.In the second graph,the firm is making economic profits as the price is more than its SAC.

Now in the perfect competition there is complete freedom for new firms to enter and for the existing firms to exit the market which shows that in the long run the loss-making firms will exit the market which will lower the market supply and increase the price until it is equal to the LAC

Also if the existing firms are making profits then freedom of entry will ensure that new firms will enter the market which will increase the market supply and lower the price of the good until it is equal to the LAC

So,in both the cases when the price = average no firms will have any incentive to either enter the market or exit the market so that they will always break even and earn zero profits in the long run as shown above.

Rahul Sunny answered 1 year ago

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