3.10 Perfect Competition in the Short Run and Long Run

Short-run profit or loss

A perfectly competitive firm produces where MR = MC (with P = MR). Compare price to ATC at that quantity: if P > ATC, the firm earns economic profit; if P < ATC but P > AVC, it minimizes losses by staying open (loss < fixed cost); if P < AVC, it should shut down immediately since variable costs aren't covered.

Entry, exit, and long-run equilibrium

Economic profit attracts new entrants, shifting market supply right and lowering price until profit = 0. Losses cause exit, shifting supply left and raising price. In long-run equilibrium, firms earn zero economic profit: P = MR = MC = minimum ATC. This is the point of productive efficiency.

Efficiency outcomes

Long-run equilibrium in perfect competition delivers both productive efficiency (producing at minimum ATC, using resources at lowest cost) and allocative efficiency (P = MC, producing the quantity society values most). No firm has incentive to enter, exit, expand, or contract.

Key terms

Shutdown rule (short run)

Shut down if P < AVC; the firm cannot cover variable costs, so it minimizes losses by producing zero output.

Short-run loss-minimizing condition

If AVC < P < ATC, the firm stays open in the short run because it covers variable costs and part of fixed costs.

Long-run equilibrium condition

P = MR = MC = minimum ATC; firms earn zero economic profit.

Productive efficiency

Producing at the minimum point of the ATC curve — using resources at the lowest possible cost.

Allocative efficiency

Occurs when P = MC; the quantity produced matches what consumers value most, maximizing total surplus.

Try an AP-style question

In long-run equilibrium, perfectly competitive firms earn…

1. zero economic profit
2. losses
3. positive economic profit
4. monopoly profits