Long-Run Equilibrium in Perfect Competition

You’ll be able to

Explain how entry and exit drive economic profit to zero
State the three conditions that hold in long-run competitive equilibrium
Explain why perfect competition is both productively and allocatively efficient

Entry and exit are the mechanism

If firms in a competitive industry earn positive economic profit, new firms enter. Industry supply shifts right, the market price falls, and profit shrinks. If firms make losses, some exit, supply shifts left, price rises, and losses shrink. Either way the process continues until economic profit is exactly zero — which is a stable resting point, because at zero nobody has a reason to move.

The long-run equilibrium condition

P = MR = MC = minimum ATC

Four things equal at once. P = MR comes from price-taking, P = MC from profit maximization, and P = minimum ATC from free entry and exit.

Why each equality holds

P = MR because a competitive firm is a price taker — it can sell any quantity at the market price, so each extra unit adds exactly the price to revenue. MR = MC because that is profit maximization. P = minimum ATC because entry and exit have eliminated economic profit, and zero profit with P = MC can only happen where MC crosses ATC, which is ATC's minimum. So the firm ends up producing at the lowest possible average cost, not by intention but by competitive pressure.

Both efficiencies at once

Producing at minimum ATC is productive efficiency — the good is made as cheaply as possible. P = MC is allocative efficiency — the last unit is valued by consumers at exactly what it costs society to make. Perfect competition achieves both simultaneously, which is why it is the benchmark against which monopoly is judged in Unit 4. Monopoly fails both: it produces above minimum ATC and prices above MC.

Worked example

A competitive industry is in long-run equilibrium when demand rises permanently. Trace the short-run and long-run adjustment.

1.Higher demand raises the market price above minimum ATC.
2.Existing firms produce more along their MC curves and earn positive economic profit.
3.Positive profit attracts entry, shifting industry supply right.
4.Price falls back toward minimum ATC, and entry stops when economic profit returns to zero.
5.The industry ends larger, with more firms, but each firm back at minimum ATC and zero profit.

Answer: Short run: higher price, higher output per firm, positive economic profit. Long run: entry drives price back to minimum ATC and profit back to zero, with a larger industry made up of more firms each producing at its original efficient scale.

Watch out

Zero economic profit does not mean the firm earns nothing. It earns a normal profit — the full opportunity cost of the owner's labor and capital. An answer suggesting owners work for free misunderstands what implicit costs are.

Checkpoint

In long-run competitive equilibrium, price equals:

Checkpoint

Firms in a competitive industry are earning positive economic profit. In the long run:

Checkpoint

Perfect competition is allocatively efficient because:

On the exam

Free responses often ask for both the short-run and long-run outcome. Answer them as two separate stages, and state explicitly that entry or exit is what moves the market between them — the mechanism is usually its own point.

Answer the 3 checkpoints as you read.