Welcome back to my blog! Last time, we began to introduce the perfect competition market. In Today’s blog, I will begin with the introduction of  long run and short run situation for this market.

Just a memory recall! The perfect competition market is an ideal market structure that has many buyers and sellers, with identical or homogeneous products and no barriers to entry.

Generally speaking, a perfectly competitive firm could be making super normal profit, a loss, or just normal profit, depending on the given market price In the short run. If the firm’s losses get too big in the short run (Like I mentioned in my last blog), then it will have to shut down.

In this diagram above, the firm wants to maximize profits at a given price P1, so it produces at point A (MC = MR) with the output Q1. At Q1, Average Revenue is greater than Average Cost, the distance AB is the profit per unit, total super normal profit is the area ABCP1 (the green box = profit per unit times output Q1 ).

In this diagram, at price P2, Average Cost curve is above the Average Revenue curve at all levels of output. The firm will want to minimize its losses, and that can be done when MC = MR at point D giving output Q2. At Q2, Average Revenue is less than Average Cost, and the distance DE is the loss per unit, so the total loss is the area DEFP2 (the red box = loss per unit x output Q2).

In this diagram, at given price P3, MC = MR occurs at point G, giving output Q3, at this point Average Revenue is equal with Average Cost, so the firm is making normal profit.

However, in the long run, all firms in a perfectly competitive market earn only normal profit. Firms are both allocative efficient (Price = MC) and productively efficient (at equilibrium output, MC = AC). A market has not failed if it is efficient in both ways (That is exactly what I mentioned in my first blog).

In the diagrams above, at initial market  price P1, each firm’s demand curve is D1. MC = MR occurs at point A. Average Revenue is greater than Average Cost, so each firm is making super normal profits. New firms will be attracted into the market since this super profit exist, and shifting supply curve to the right. This will keep happening until all firms earn only normal profit. Once S1 shifted to S2, at P2, every firm in the industry will be earning normal profit, no incentive for any new firm to enter or leave the industry. This is the long run equilibrium.

That’s all for the perfect competition market. Next time, we will talk about the Monopolistic Competition market.