The falling prices put pressure on the less efficient firms. ![]() ![]() This can be seen in Figure 4 below.įigure 4 Long run equilibrium in perfect competition The long run equilibrium is where MC = MR = AC = AR. Each of the firms will now be in long run equilibrium earning only normal profit. The supernormal profits were competed away and equilibrium was reached where only normal profit was earned. The presence of SNP's has attracted more firms to the market and this has led to the price falling. Look at the modified diagram below.įigure 3 The impact on a market of supernormal profit It charges P2 (the same as the market price) and so now sells Q2. The original firm has to lower its price or it will sell nothing. Supply increases (the supply curve shifts to the right - S2 in Figure 3 below) and prices fall. This is shown below.įigure 2 Firm in perfect competition making supernormal profitĬompetition is perfect. It is able to make supernormal profits at this stage. It sells Q1 units of its product at price P1. What does this mean for prices and competition? Consider the following case.Ī firm enters a perfectly competitive market with a product. If firms are making consistently below normal profits then they will choose to leave the industry. However, this supernormal profit will be a signal to other firms and will attract more firms into the industry. We call this supernormal (or abnormal) profit. Anything in excess of normal profits is called abnormal or supernormal profits.Īny profit above normal profit is a 'bonus' for the firms, as it is more than they need to keep them in the industry. In other words it is enough profit to keep them in the industry. Normal profit is the level of profit that is required for a firm to keep the resources they are using in their current use. This level of profit is just enough to keep them in the industry and since profits are adequate they have no incentive to leave. Onto this we superimpose the marginal and average cost curves and this gives us the equilibrium of the firm.įigure 1 Equilibrium of the firm and industry in perfect competitionįirms in equilibrium in perfect competition will make just normal profit. This price represents their average and marginal revenue curve. The firm as a price taker simply 'takes' and charges the market price (P* in Figure 1 below). The market is modelled by the standard market diagram (demand and supply) and the firm is modelled by the cost model (standard average and marginal cost curves). In perfect competition, the market is the sum of all of the individual firms.
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