The firm is in equilibrium at point e where MC = MR.

At this point the firm is making losses because she produces at a higher average cost C and sells at a lower price Pe Thus, the shaded area PeCFe represents the losses made by the firm in the short run.

Long run equilibrium position of the firm.

In the long run, all firms underperfect competition earn normal profits i.e. they neither earn abnormal profits nor make losses. This is because of the freedom of entry and exit in the market.

Abnormal profits earned in the short run attract other firms to join the industry. Eventually, output increases leading to fall in price and fall in profit until all firms earn normal profits in the long run. In case of losses, firms leave the industry leading to reduction in output and an increase in price. The profit level will also increase gradually until firms earn normal profits in the long run.

LMc = Long run Marginal cost

LMR = Long run Marginal Revenue

Point e is the longrun equilibrium position of the firm. At that point marginal cost is equal to marginal revenue (LMC = LMR)

Note: The requirement that MC =MR should be the equilibrium of the firm is just a necessary but not a sufficient condition for profit maximisastion under perfect competition. The sufficient condition for profit maximization requires that the slope of the MC curve should be positive i.e the MC curve should cut the MR from below.

 

Figure 2.25 Sufficient condition for profit maximization

At point A, MC = MR and also at point B, MC =MR. So, which of the two points represents the equilibrium of the firm under perfect competition?