In the diagram below, a firm is operating in an imperfect marketThe firm will only make normal profits in the long-run when

Question

BlackTom AI · Accepted Answer

To understand when a firm in an imperfect market earns normal profits in the long run, we need to consider how profits are driven to zero by entry and exit. In the long run, if firms in the industry make profits (price above average cost), new firms will enter, shifting supply and pushing the price down until profits disappear. Conversely, if firms incur losses (price below average cost), some firms will exit, reducing supply and pushing the price up until losses disappear.

In this context, normal profit occurs precisely when price is equal to average cost, so that total revenue just covers all costs, including the opportunity cost of the entrepreneur’s capital. This condition is P = AC, which in the diagram corresponds to the AR (price) line intersecting the minimum of the LRAC (average cost) or at a tangent where AR = AC.

Option: AR = AC. This reads as price equals average cost, which indicates zero economic profit in the long run. Why this is correct: with free entry and exit characteristic of many imperfect markets, firms cannot sustain profits above zero in the long run, because any such profits attract new entrants until profits are eroded to zero; at the same time, losses push exits until only normal profits remain. Hence AR = AC ensures the firm earns a normal return, not an supernormal profit or a loss.

Why not AR > AC? If AR were greater than AC, the firm would be earning positive economic profit, drawing in new entrants and expanding supply, which would lower the price until profits fall back toward zero. The same logic applies in reverse for AR < AC: losses would trigger exit and reduce supply, raising the price back to the point where AR = AC.

In summary, in the long run within an imperfect market framework, normal profits arise where price equals average cost (AR = AC), ensuring zero economic profit after entry and exit have adjusted the market. The key mechanism is the adjustment of market supply through entry and exit until profits are exactly normal.

In the diagram below, a firm is operating in an imperfect marketThe firm will only make normal profits in the long-run when

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