Profit Maximising Equilibrium in SR & LR

• Explain the profit maximising equilibrium in the short run - perfect competition?


  In the short run, a firm in perfect competition seeks to maximise its profit or minimise its loss. To determine the profit-maximising output and price in the short run, a firm compares its marginal cost (MC)with the market price (P).
• What is the short-run profit maximisation rule?


  1. If MC<P, the firm should increase its output because producing one more unit adds more to the revenue than to cost.
  2. If MC>P, the firm should decrease its output because producing one more unit adds more to cost than to revenue.
  3. If MC=P, the firm is maximising its profit at the current output level.
• The firm in perfect competition will produce on what conditions?


  The firm will produce as long as P covers the average variable cost (AVC). If P is greater than or equal to AVC but less than average total cost (ATC), the firm will continue to produce in the short-run, even if it incurs a loss.
• Explain the profit maximising equilibrium in the long run?


  In the long-run, firms in perfect competition adjust to reach a state of zero economic profit.
• What does firms in perfect competition reaching zero economic profit in the long run involve?

  1. If firms are making economic profit in the short-run, new firms will enter the market due to the absence of entry barriers. This increases supply, lowers prices, and reduces the profits of existing firms.
  2. If firms are incurring losses in the short run, some firms will exit the market, reducing supply, raising prices, and allowing remaining firms to potentially cover their costs.
• How does the process leading to long run zero economic profit continue?


  This process continues until all firms in the industry earn only normal profit, where P=ATC. In the long run equilibrium, no firm is making economic profit or incurring economic losses, and resources are efficiently allocated.