Determination of Long Run Equilibrium of a Firm

• All factors of production are variable.
• The firm can change plant size and scale of production fully.
• New firms can enter the industry and existing firms can leave (free entry and exit).

A firm is in long-run equilibrium when:

• It has no tendency to change its output or scale of plant.
• It earns only normal profit.

Why only normal profit in the long run?

1. If firms earn supernormal profit:

• New firms enter the industry (because entry is free).
• Industry supply increases → market price falls.
• Profit falls to normal profit level.

2. If firms incur losses:

• Some firms leave the industry.
• Industry supply decreases → market price rises.
• Losses reduce and move to normal profit.

So, entry and exit continue until each firm earns only normal profit.

1. Profit-maximisation condition

• Long-run marginal cost equals marginal revenue:
  LMC = MR
• The LMC curve cuts the MR curve from below at the equilibrium output.

2. Normal profit condition

• Average revenue equals long-run average cost:
  AR = LAC

Under perfect competition, AR = MR = Price. So, at long-run equilibrium:

Price = AR = MR = LMC = minimum LAC

This means:

• The firm is producing at the minimum point of its LAC curve.
• It achieves productive efficiency (lowest possible cost per unit).
• It earns normal profit, not supernormal profit.

Case 1: Super-normal profit

• At first, price is high and firms earn supernormal profit.
• New firms enter the industry.
• Industry supply increases → supply curve shifts right.
• Market price falls.
• As price falls, supernormal profits shrink.
• Entry stops when price = minimum LAC and firms earn only normal profit.

Case 2: Losses

• At first, price is low and firms make losses (price < AC).
• Some firms exit the industry.
• Industry supply decreases → supply curve shifts left.
• Market price rises.
• As price rises, losses reduce.
• Exit stops when remaining firms again earn only normal profit at minimum LAC.

The industry (all firms producing the same product) is in long-run equilibrium when:

• Market demand equals market supply at a stable price.
• There is no tendency for firms to enter or exit the industry.

This happens when:

• Every firm in the industry is in its own long-run equilibrium:
  P = AR = MR = MC = minimum LAC.
• Each firm earns normal profit.

Think of small coaching centres in a city:

• When coaching fees and profits are high, more people open coaching centres. As the number of centres increases, each one gets fewer students, and some may cut fees. Profits come down towards a normal level.
• If profits fall too much and some centres start making losses, a few centres close. With fewer centres, each gets more students and can charge better fees. Profits rise back to a normal level.

This is similar to long-run equilibrium in perfect competition: free entry and exit push profits towards normal profit.

• Long run: all factors variable; firms can freely enter or exit the industry.
• In long-run equilibrium under perfect competition:
  Each firm earns only normal profit.
  Each firm produces at the minimum point of LAC.
  Price = AR = MR = MC = minimum LAC.
• Industry is in long-run equilibrium when market demand = market supply and there is no tendency for entry or exit.
• Supernormal profits cause entry and lower prices; losses cause exit and higher prices; both processes move the industry to normal profit in the long run.