23 Jun 2022


Economic Profits or Losses in a Perfect Competition Market

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Perfect competition is an industry characterized by many companies that produce and sell homogeneous products to many consumers, absence of entry restrictions, lack of advantages by old businesses over new businesses, and informed consumers. There are no economic profits or losses in the long run in a perfect competition because businesses do not have entry barriers; an infinite number of businesses that produce infinitely divisible and homogeneous goods eliminate losses and profits, and consumers have perfect information. 

The main drivers of whether or not a company can enter a perfectly competitive market, in the long run, are profits. All companies have equal access to resources and they are free to enter and exit the market. When an industry experiences high product prices, businesses are stimulated to enter the industry or expand their production to earn more profits. The entry of new companies results in the shifting of the supply curve to the right, which leads to a reduction in prices and decreases in profits. As companies continue entering the industry, the economic profit reduces to zero, which compels some companies that are experiencing losses to exit the industry. In turn, this results in the shifting of the supply curve to the left, which increases prices and decreases losses. As companies continue leaving, the remaining companies start experiencing profits until the profits reach zero. 

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Production costs for existing companies and new companies can stay unchanged, increase, or decrease. For unchanged costs (constant cost sectors), high market demand and increased prices leads to the movement of the supply curve to the right as new companies enter the industry. When the new long-term equilibrium intersects at the same price as it was earlier, the curve stops moving. Companies can meet consumer demand easily and they can increase the employee demand without increasing wages (Wisner, 2014). 

For companies that experience high production costs after the entry of new companies (increasing cost industries), the expansion of the market causes both existing and new companies to experience high production costs. The long-term equilibrium intersects at a higher price than it was earlier, which compels companies to restrict their inputs of, for example, skilled personnel. Wages of these staff increase as their demand increase, which increases production costs for all companies in the industry (Blanchflower & Bryson, 2004). 

For companies that experience low production costs due to high demand (decreasing cost industries) caused by the entry of new companies, the long-term equilibrium intersects at a lower price than it was earlier. Factors, such as high levels of employee education or technology improvement cause a reduction in the cost of production (West, 2016). 

The absence of entry restrictions in a perfectly competitive market attracts numerous firms to operate. The combination of numerous companies entering the current industry influences the overall market supply. For example, all companies in a perfectly competitive industry produce the same kind of products and sell only a small proportion of their entire products. In turn, this prevents an individual company from influencing the price of products. A single company in this market is small compared to the entire industry and it can sell the number of products it wants without reducing its price because it produces identical products as other companies in the industry. 

Consumers in a perfectly competitive market also possess perfect information about product prices. Deals between sellers and consumers occur at a single market price. Consumers perceive the products of all companies to be identical and know the prices of all products, which mean that they will buy products at the lowest market price (Li, Yan & Xiao 2014). If a single company attempts to increase its price consumers will not buy from it because they will simply switch to another company. Companies, thus, are compelled to charge the same price in a perfectly competitive market. 


In a perfect competition industry, companies do not gain or lose in the long run because companies react to profits by entering the market in which old companies increase production while new companies enter the industry. Companies also react to losses by leaving the market in which the remaining companies decrease their production. The entry and exit processes force the price level to move toward the point of zero profit. 


Blanchflower, D. G., & Bryson, A. (2004). What effect do unions have on wages now and would Freeman and Medoff be surprised?.  Journal of Labor Research 25 (3), 383-414. 

Li, S., Yan, J., & Xiao, B. (2014). Contract Design and Self ‐ Control with Asymmetric Information.  Economic Inquiry 52 (2), 618-624. 

West, D. M. (2016, July 29). How technology is changing manufacturing. Retrieved November 25, 2018, from https://www.brookings.edu/blog/techtank/2016/06/02/how-technology-is- changing-manufacturing/ 

Wisner, R. (2014). Ethanol, Gasoline, Crude Oil and Corn Prices: Are the Relationships Changing? Retrieved November 25, 2018, from https://www.agmrc.org/renewable- energy/renewable-energy-climate-change-report/renewable-energy-climate-change- report/march--april-2014-newsletter/ethanol-gasoline-crude-oil-and-corn-prices-are-the- relationships-changing/ 

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