Question

Describe the process by which the short-run super-normal profits of firms in a perfectly competitive industry are wiped out in the long-run.

Answer 1

1. In the long run, a firm under perfect competition earns only normal profits, and this is ensured by the free entry and exit of firms.
2. If firms earn supernormal profits in the short run, new firms enter the industry. This increases total supply, shifts the supply curve to the right, and lowers the market price. As the price falls, abnormal profits reduce. This continues until price equals average cost, and all firms earn normal profits.
3. If firms face losses, some firms will exit the industry. This reduces supply, shifts the supply curve to the left, and raises the price. Exit continues until remaining firms cover their costs and again earn normal profits.
4. Thus, in the long run, a firm under perfect competition can earn neither super-normal profits nor losses, only normal profits, maintaining a stable and balanced market.