Long-run economic profit for perfectly competitive firms

let's dig a little bit deeper into what happens in perfectly competitive markets in the long run so what we have on the left-hand side and we've seen this multiple times already is our supply and our demand curves for our perfectly competitive market and you can see the equilibrium price right over here marked with this dotted line and as we've talked about in multiple videos the firms in that perfectly competitive market the perfectly competitive firms they just have to be price takers so the market price is going to be their marginal revenue curve it's going to be this horizontal curve and it would be rational for them to produce the quantity so they're not going to set the price but they can choose what quantity to produce but it would be rational for them to keep producing while the marginal revenue is higher than the marginal cost up to and including when the marginal revenue is equal to the marginal cost so for this firm at this current state of affairs it would be rational for them to produce this quantity right over there and as we've talked about in other videos at that quantity they are going to make an economic profit and the way that we can see that is at this quantity this is the average total cost that is your marginal revenue and so you are going to get this much per unit and then you multiply so the height is how much you get per unit and then you multiply that times the number of units so the area of this rectangle is that positive economic profit that this firm will have now that's in the short-run but now let's think about what will likely happen in the long run if folks see other folks making a positive economic profit remember economic profit doesn't just account for regular cost it also includes opportunity cost so a lot of people say hey I would want to put my resources into this market so that I can make that positive economic profit as well but what's going to happen as you have entrance into this market well that's going to shift the supply curve to the right at any given price you're going to have more supplies one way to think about it so if that's a supply curve let's just call that one now you're going to have more entrance more entrance and what's going to happen well you might get to something like you might get to a situation like this actually let me see if I can draw it well you might get to a situation like this where you have more entrance and you go to supply curve to now what's going to be the quantity that firm a produces in that world remember firm a is just one of many firms well in this situation we have a new equilibrium price so if this was P sub one now we have this new equilibrium price P sub 2 which is going to define a new marginal revenue curve for all of the players in this perfectly competitive market and so the new marginal revenue curve is going to be right over there now in this situation what is the rational quantity for firm a to produce well once again as long as marginal revenue is higher than marginal cost it makes sense for them to produce more and more and more up until the point that they are equal so now firm a would want to produce less because the market price that it just has to take is less but notice what happens as more and more entrants got into the market the market price which also defines this horizontal marginal revenue curve went lower and lower lower to the point where firm a now in this situation is making no economic profit at this point we not only is marginal revenue intersecting marginal costs but that's exactly at the point at which marginal cost is equal in average total cost so one way to think about it is in a perfectly competitive firm they are productively efficient they are producing the quantity that minimizes their average total cost we've already talked about that point where marginal cost and average total costs intersect that's going to be the minimum point for average total cost and why is that well while while at marginal cost is below average total cost average total cost is going to get lower and lower and lower and then once marginal cost gets high than average total cost well then the average total cost curve will start going curving up so we just saw a situation that even where we see economic profit in the short run in the long run entrants are going to go into that market and it's going to reduce the economic profit down to zero and at that point the firm that has that zero economic profit they are productively efficient they are producing at the minimum point of their average total cost curve and we've already talked before that this equilibrium point right over here in our market because our demand and supply curves are the intersection point is the price defines the price our equilibrium price and quantity x' we are also allocated li efficient we've talked about things like deadweight loss in the past that is not happening right over here our marginal benefit is equal to our marginal cost right at that equilibrium price and quantity now some of you might be saying well what about the other situation what about if if for some reason we were in a let's call it a supply curve let's see people over shot too many people joined into this market so let's say we went to supply curve three well what's going to happen and let me label this this is right over here this is marginal revenue curve one which is equal to price one this is marginal revenue curve two which is equal to price two and then this would define so this right over here would be price three price three which would define marginal revenue curve three so marginal revenue curve three which is equal to price three well if too many entrants joined into that market now firm a has a more difficult to scenario they are would produce at this quantity we've talked about many times already but at that quantity each unit their average total cost is higher than that revenue they're getting so they're going to be running at an economic loss in the short-run but what would happen in the long-run well firm a in the long-run would probably exit the market in other firms who are running an economic loss would exit the market and so that would shift the supply curve back to the left and so we would eventually get once again to that reality where firms have no economic profit in there and we have a market that is allocated li efficient no deadweight loss and firms are producing at the minimum point of their average total cost curve which is known as productive efficiency are productively efficient