Answer to Question #131031 in Microeconomics for ismail lodin

Question

III. Why does a competitive firm make normal profits in long run?

Answer 1

A competitive firm makes normal profits in the long run due to the existence of freedom of entry and exit in the perfectly competitive market, and due to the existence of supernormal profits in the short run.

Supernormal profits existing in the short run attract the entrance of new firms into the market in the long run. Due to absense of barriers to entry and exit, new firms easily enter the market thereby increasing the market supply. The increase in market supply results in a decrease in market equilibrium price. As a result, the average revenue of individual firms decrease until it becomes tangential to the average total cost curve at which point firms start earning normal profits.

Thus, new firms enter the market until all supernormal profits are competed off, that is, until individual firms start earning normal profits.