Long-run Perfect competition confusion
Hi guys,
I have had a problem with understanding long-run perfect competition. Wikipedia states that "Only normal profits arise in circumstances of perfect competition when long-run economic equilibrium is reached; there is no incentive for firms to either enter or leave the industry." This confuses me, as to my understanding when a firm makes a normal 'profit', it is actually just breaking-even in business profit terms. Surely, in that case, firms do have an incentive to leave the market - they are wasting their time by breaking-even and can easily, due to a lack of exit barriers under PC, turn to other industries/sectors where they can make a supernormal profit.
My only interpretation to make sense of this is that the 'long-run' never really exists in this already theoretical scenario; more firms enter the market in the short-run to make a supernormal profit, driving the market price (AR/MR) of the good being sold downwards, therefore tending towards but never reaching (or at least only reaching for a VERY short period of time) the ATC curve. However, surely firms will start to leave the market once the level of supernormal profit becomes unsatisfactory (or at least zero/non-existent), once again raising AR/MR.
Please could somebody help to clarify my confusion? Thank you!
I have had a problem with understanding long-run perfect competition. Wikipedia states that "Only normal profits arise in circumstances of perfect competition when long-run economic equilibrium is reached; there is no incentive for firms to either enter or leave the industry." This confuses me, as to my understanding when a firm makes a normal 'profit', it is actually just breaking-even in business profit terms. Surely, in that case, firms do have an incentive to leave the market - they are wasting their time by breaking-even and can easily, due to a lack of exit barriers under PC, turn to other industries/sectors where they can make a supernormal profit.
My only interpretation to make sense of this is that the 'long-run' never really exists in this already theoretical scenario; more firms enter the market in the short-run to make a supernormal profit, driving the market price (AR/MR) of the good being sold downwards, therefore tending towards but never reaching (or at least only reaching for a VERY short period of time) the ATC curve. However, surely firms will start to leave the market once the level of supernormal profit becomes unsatisfactory (or at least zero/non-existent), once again raising AR/MR.
Please could somebody help to clarify my confusion? Thank you!
Normal profit is still good for companies. It means it can pay its employees whilst still having some money. Break even is just a saying because they are not earning any more additional money than needed. So yes if they wanted to make supernormal profit which is profit but at a greater level, then they can leave.
Normal profit - no dynamic efficiency so they cant invest however they are paying employees which is good enough. Also they are still getting paid bonuses and stuff
Normal profit - no dynamic efficiency so they cant invest however they are paying employees which is good enough. Also they are still getting paid bonuses and stuff
In economic terms, normal profits imply that all factors of production can be paid for, with nothing in excess.
http://www.tutor2u.net/economics/reference/factors-of-production
Land - rent
Labour - wages
Capital - interest
Entrepreneurship - profit
From that link, you can see that entrepreneurship is a factor of production. Firms may be 'breaking even' but this is not in business terms. This breaking even includes a fair return for investors (profit in business terms), compared to if they were to invest their capital elsewhere.
I think where you are confused is with the different use of the term profit. The use of normal 'profits' is confusing when this also covers the profit made by investors.
http://www.tutor2u.net/economics/reference/factors-of-production
Land - rent
Labour - wages
Capital - interest
Entrepreneurship - profit
From that link, you can see that entrepreneurship is a factor of production. Firms may be 'breaking even' but this is not in business terms. This breaking even includes a fair return for investors (profit in business terms), compared to if they were to invest their capital elsewhere.
I think where you are confused is with the different use of the term profit. The use of normal 'profits' is confusing when this also covers the profit made by investors.
Original post by Speckle
In economic terms, normal profits imply that all factors of production can be paid for, with nothing in excess.
http://www.tutor2u.net/economics/reference/factors-of-production
Land - rent
Labour - wages
Capital - interest
Entrepreneurship - profit
From that link, you can see that entrepreneurship is a factor of production. Firms may be 'breaking even' but this is not in business terms. This breaking even includes a fair return for investors (profit in business terms), compared to if they were to invest their capital elsewhere.
I think where you are confused is with the different use of the term profit. The use of normal 'profits' is confusing when this also covers the profit made by investors.
http://www.tutor2u.net/economics/reference/factors-of-production
Land - rent
Labour - wages
Capital - interest
Entrepreneurship - profit
From that link, you can see that entrepreneurship is a factor of production. Firms may be 'breaking even' but this is not in business terms. This breaking even includes a fair return for investors (profit in business terms), compared to if they were to invest their capital elsewhere.
I think where you are confused is with the different use of the term profit. The use of normal 'profits' is confusing when this also covers the profit made by investors.
Ok thanks, I think I get what you're saying. So do shareholder profits essentially count as a cost, and under normal profit, no profit is made in the sense that there is no retained profit left for the company to invest in r&d and other practices generating economies of scale after shareholders have been paid - therefore keeping the market homogenous and perfectly competitive?
Someone correct me if I'm wrong but normal profit is greater than accounting/business profit. Normal profit means that zero economic profit is obtained but by staying in the market, they are earning the same as they would elsewhere, i.e. they cover their opportunity costs. Therefore they can't go and enter another industry for supernormal profit because by definition, normal profit is as good as they can get.
Original post by BasicMistake
Someone correct me if I'm wrong but normal profit is greater than accounting/business profit. Normal profit means that zero economic profit is obtained but by staying in the market, they are earning the same as they would elsewhere, i.e. they cover their opportunity costs. Therefore they can't go and enter another industry for supernormal profit because by definition, normal profit is as good as they can get.
Thanks for the reply! Upon further research I came to realise this! I was just confused as the textbook failed to differentiate between economic profit and accounting profit.
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