Question

Explain the equilibrium of firm under perfect competition.

Answer 1

In the long run, a firm under perfect competition is in equilibrium when it earns only normal profit. This happens because of the freedom of entry and exit in the industry.

If firms earn super-normal profits in the short run, new firms enter. This increases supply, causing the price to fall. The process continues until profits fall to normal levels.

If firms incur losses, some will exit the industry. This reduces supply, causing the price to rise. Exit continues until losses disappear and firms again earn normal profit.

Thus, in the long run, firms can neither earn super-normal profit nor face losses. They just cover all costs and earn a normal profit.

For long-run equilibrium, two conditions must be met:

• LMC = MR, and LMC cuts MR from below (profit-maximizing condition).
• AR = LAC, meaning firms earn normal profit.

Since under perfect competition AR = MR, the full equilibrium condition becomes:

LMC = MR = AR = LAC

This occurs at the minimum point of the LAC curve, which is the optimum output level. Here, the firm is most efficient and in full equilibrium.