Section 5.3

Perfect Competition in the Long Run

How market forces drive perfectly competitive industries toward equilibrium through firm entry, exit, and the elimination of economic profits.

Entry & Exit
Zero Economic Profit
Consumer Benefits

Entry and Exit of Firms

In the long run, firms can freely enter or exit the industry based on profitability. This mechanism drives the market toward equilibrium.

Firm Entry

When: P > ATC (Economic Profit Exists)

1

Existing firms earn economic profits, attracting new entrepreneurs

2

New firms enter the industry (no barriers to entry)

3

Market supply increases (supply curve shifts right)

4

Market price falls until P = ATCmin

Firm Exit

When: P < ATC (Economic Losses Exist)

1

Firms suffer economic losses (revenue doesn't cover all costs)

2

Some firms exit the industry (free exit)

3

Market supply decreases (supply curve shifts left)

4

Market price rises until P = ATCmin

The Self-Correcting Market

This entry/exit mechanism acts as a self-correcting force in competitive markets. Economic profits signal new firms to enter, while losses signal firms to exit. The market naturally adjusts until no firm has an incentive to enter or leave.

Long-Run Equilibrium

Long-run equilibrium is reached when there is no incentive for firms to enter or exit the industry. At this point, all firms earn zero economic profit.

Conditions for Long-Run Equilibrium:

  • P = MC: Firms maximize profit (short-run condition)
  • P = ATCmin: Zero economic profit (no entry/exit incentive)
  • MC = ATCmin: Production at minimum average cost

The "Triple Equality"

In long-run equilibrium: P = MR = MC = ATCmin

This represents the most efficient possible outcome for society.

Long-Run Equilibrium Graph

Price/Cost
Quantity MC ATC
P = MR = ATCmin
Q*
P = MR (at ATC minimum)
MC (passes through ATC minimum)
ATC (U-shaped curve)
Long-run equilibrium point

Zero Economic Profit

Understanding what zero economic profit really means and why it's the long-run outcome in perfect competition.

What is Zero Economic Profit?

Zero economic profit does NOT mean the firm earns nothing. It means:

  • All explicit costs are covered – wages, rent, materials, etc.
  • All implicit costs are covered – opportunity cost of owner's time and capital
  • Normal profit is earned – the minimum return needed to keep resources in current use

Key Distinction: Economic profit = Accounting profit – Opportunity costs. Zero economic profit means the firm earns exactly what it could earn in its next best alternative.

Why Zero Economic Profit?

Competition and free entry/exit drive profits to zero:

If Economic Profit > 0:

New firms enter → Supply increases → Price falls → Profit decreases

If Economic Profit < 0:

Firms exit → Supply decreases → Price rises → Losses decrease

If Economic Profit = 0:

No incentive to enter or exit → Equilibrium achieved

The Paradox of Competition

Individual firms try hard to maximize profits, yet competition ensures that in equilibrium, no firm earns more than normal profit. This is the "invisible hand" at work – self-interested behavior leads to socially optimal outcomes.

Consumer Benefits of Perfect Competition

Perfect competition delivers significant benefits to consumers through two key pricing outcomes.

Minimum-Cost Pricing

In long-run equilibrium, firms produce at the minimum point of their ATC curve. This is called productive efficiency.

P = ATCmin

Price equals minimum average total cost

Benefits for Consumers:

  • Goods produced at lowest possible cost per unit
  • No resources wasted in production
  • Lowest sustainable price for consumers

Marginal-Cost Pricing

Firms produce where price equals marginal cost. This is called allocative efficiency.

P = MC

Price equals marginal cost

Benefits for Consumers:

  • Resources allocated to their highest-valued uses
  • Consumer satisfaction is maximized
  • No deadweight loss (maximum total surplus)

The Efficiency Ideal

Perfect competition achieves both productive efficiency (P = ATCmin) and allocative efficiency (P = MC) simultaneously.

This is why economists use perfect competition as a benchmark to evaluate other market structures. No other market structure achieves both efficiencies in the long run.

The Long-Run Adjustment Process

How markets self-correct through firm entry and exit to reach long-run equilibrium.

Scenario 1: Economic Profits Exist

Starting Point: P > ATC (firms earning positive economic profit)

1

Initial State

Firms earn economic profit (P > ATC)

2

Entry Occurs

New firms attracted by profits enter market

3

Supply Increases

Market supply shifts right

4

Price Falls

Increased supply lowers market price

5

Profits Decrease

Lower P reduces profit per unit

6

Equilibrium

Entry stops when P = ATC (π = 0)

Scenario 2: Economic Losses Exist

Starting Point: P < ATC (firms incurring losses)

1

Initial State

Firms incur losses (P < ATC)

2

Exit Occurs

Unprofitable firms leave the market

3

Supply Decreases

Market supply shifts left

4

Price Rises

Decreased supply raises market price

5

Losses Decrease

Higher P reduces losses

6

Equilibrium

Exit stops when P = ATC (π = 0)

Key Takeaway: The Invisible Hand at Work

The long-run adjustment process demonstrates Adam Smith's "invisible hand" in action. Individual firms pursuing their own self-interest (entering when profitable, exiting when unprofitable) automatically drive the market toward an efficient equilibrium where P = MC = ATCmin. No central planner is needed – the market self-corrects through the actions of profit-seeking firms.

Econ Humor

Meme Break: Long-Run Edition

Economic profit in perfect competition:

💰➡️🚪➡️📉➡️😐

"I'm making profits!"

*New firms enter*

"Aaaand it's gone." 📊

Zero economic profit:

🤔💭💵

"Wait, zero profit sounds terrible!"

Economist: "No no, you still earn NORMAL profit..."

"It's ECONOMIC profit that's zero!"

Everyone: 😵‍💫

The invisible hand works in mysterious ways!

Continue Your Learning Journey

Now explore how demand differs in imperfectly competitive markets like monopolistic competition and oligopoly.

Next: Demand Differences Back to Short Run