Question

explain the process of making normal profits in the long run for a perfectly competitive firm?​

Answer 1

Answer:

The long run is a period of time which is sufficiently long to allow the firms to make changes in all factors of production. In the long run, all factors are variable and none fixed. The firms, in the long run, can increase their output by changing their capital equipment; they may expand their old plants or replace the old lower-capacity plants by the new higher-capacity plants or add new plants.

Besides, in the long run, new firms can enter the industry to compete the existing firms. On the contrary, in the long run, the firms can contract their output level by reducing their capital equip­ment; they may allow a part of the existing capital equipment to wear out without replacement or sell out a part of the capital equipment.

Moreover, the firms can leave the industry in the long run. The long-run equilibrium then refers to the situation when free and full adjustment in the capital equip­ment as well as in the number of firms has been allowed to take place. It is therefore long-run average and marginal cost curve which are relevant for deciding about equilibrium output in the long run. Moreover, in the long run, it is the average total cost which is of determining importance, since all costs are variable and none fixed.

As explained above, a firm is in equilibrium under perfect competition when marginal cost is equal to price. But for the firm to be in long-run equilibrium, besides marginal cost being equal to price, the price must also be equal to average cost.

For, if the price is greater or less than the average cost, there will be tendency for the firms to enter or leave the industry. If the price is greater than the average cost, the firms will earn more than normal profits. These supernormal profits will attract outer firms into the industry.

With the entry of new firms in the industry, the price of the product will go down as a result of the increase in supply of output and also the cost will go up as a result of more intensive competition for factors of production. The firms will continue entering the industry until the price is equal to average cost so that all firms are earning only normal profits.

Explanation: