Q.Discuss the equilibrium of a firm under perfect competition in the long run.
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Start your 14-day free trial to unlock the full solution →In long-run equilibrium under perfect competition, free entry and exit drive price to the minimum of average cost, so each firm produces at P = MR = MC = minimum AC and earns only normal profit.
Under perfect competition, the firm is a price-taker: it faces a horizontal demand (AR) curve, and AR = MR = Price. In the long run all factors are variable and firms can freely enter or leave the industry; this freedom is the key to long-run equilibrium.
Conditions of long-run equilibrium of the firm:
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Marginal condition: Marginal Cost (MC) must equal Marginal Revenue (MR), i.e. MC = MR (= Price). This gives the profit-maximising output.
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Second-order condition: the MC curve must cut the MR curve from below, so that profit is a maximum and not a minimum.
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Normal-profit (zero economic profit) condition: Price must equal Average Cost (P = AC), so that the firm earns only normal profit and there is no super-normal profit or loss.
Why only normal profit in the long run (role of free entry and exit):
- If existing firms are earning super-normal profit (P > AC), new firms, attracted by the profit, enter the industry. This increases market supply, lowers the price, and continues until the super-normal profit disappears and P = AC.
- If firms are suffering losses (P < AC), some firms leave the industry. Market supply falls, the price rises, and this continues until the remaining firms no longer incur losses and P = AC again.
Result — the long-run equilibrium condition: …
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