Question

True or false? In long-run industry equilibrium no firm will be losing money.

Short answer

True, no firm will be losing money in long-run equilibrium.

Step-by-step solution

Understanding Long-Run Equilibrium

In the long-run equilibrium, firms in a perfectly competitive industry achieve normal profit, where total revenue equals total cost. In this scenario, firms have had time to enter or exit the industry, adjusting production so that supply meets demand at a price point where no incentives exist for firms to enter or leave.

Analyzing Firm Profit

In the long-run equilibrium, economic profits for each firm are zero. Zero economic profit means that all opportunity costs are covered, and there are no economic losses. Therefore, every firm in the industry should be covering their costs, including normal profits.

Concluding About Profit and Loss

Given that all firms are making zero economic profit and no firm has an incentive to leave the market, it is impossible for a firm to be losing money. Losses would lead firms to exit the industry, which contradicts the definition of long-run equilibrium.

Key concepts

Perfectly Competitive Industry

A perfectly competitive industry is one in which there are many firms, none of which have significant market power. This means that each firm is a price taker, relying on the market price that results from the combined supply and demand.

Firms in perfectly competitive markets sell identical products, making them perfectly substitutable for one another. This leads to:

• Free entry and exit: Firms can easily enter or exit the market due to minimal barriers.
• Perfect information: Consumers and producers have full knowledge about prices and availability.
• Numerous buyers and sellers: The market has so many participants that no single player can influence the market.

The result of these conditions is that firms in the industry strive to minimize costs to maximize their minimal profits, as prices can't be influenced upward due to fierce competition.

Normal Profit

Normal profit occurs when a firm's total revenue equals its total costs, including the opportunity cost of capital and time. It's the minimum level of profit needed for a company to remain competitive in the market.

When a firm is making normal profit, its economic profit is zero because:

• Total revenue covers all explicit and implicit costs.
• The returns are equal to what could be earned if the resources were employed in the next best alternative.

In the context of long-run equilibrium, achieving normal profit ensures that firms sustain operations without excess or loss-driven incentives to alter their market position. Therefore, it stabilizes the industry as firms generate adequate returns to keep functioning.

Economic Profits

Economic profits consider not only the explicit costs that a firm pays out but also implicit costs, which are the opportunity costs of resources utilized for production.

In economic terms, a positive economic profit means that a firm is earning a profit above the normal profit level, which incentivizes new firms to enter the industry.

• Zero economic profit indicates that the firm covers all opportunity costs and no extra earnings are made.
• Negative economic profits (losses) would prompt firms to exit the industry due to unviability in covering opportunity costs.

In the long-run equilibrium of a perfectly competitive market, economic profits tend to zero, ensuring that firms cover their opportunity costs but do not earn excess above that, maintaining industry balance.