Entry, Exit, and Long-run Equilibrium

Short-run economic profit sends a signal. If firms earn positive economic profit and entry is easy, new firms bring resources into the market. Market supply shifts right, reducing price and each firm's output and profit. Persistent losses cause exit, shifting supply left and raising price.

The zero-profit condition

For identical firms in a constant-cost competitive industry, long-run equilibrium commonly satisfies

Each firm produces at efficient scale, market quantity demanded equals total supply, and economic profit is zero. Zero economic profit includes normal returns to entrepreneurship and capital, so firms have no incentive to leave.

The adjustment is not instantaneous. Entry requires finance, permits, workers, and capacity; exit may involve contracts and specialized assets. During transition, prices and profits can differ from long-run levels.

When the industry expands

An increase in demand first raises price and incumbent profit. Entry then expands supply. In a constant-cost industry, input prices do not change and long-run price returns to the original minimum ATC. In an increasing-cost industry, expansion raises input costs and the new long-run price is higher. Industry-specific learning can instead lower costs.

Long-run zero profit does not eliminate innovation. A successful innovation can create temporary profit; imitation and entry erode it unless patents, know-how, networks, or continual improvement preserve an advantage.

Follow one full adjustment

Suppose ten identical firms initially produce ten units each at price 16, while minimum ATC is 12. Positive economic profit attracts entry. As new firms add supply, market price falls and each incumbent moves down its MC curve.

At price 12, market demand might be 120 while each efficient-scale firm produces 6. The market can then support 20 firms. Economic profit is zero: revenue covers paid costs and the normal opportunity return to owner resources.

Entry changes the market, not only firm count

It is incomplete to say “profit causes entry.” Trace the whole chain: profit signal, new firms, rightward market-supply shift, lower price, changed output per firm, and reduced profit. Loss and exit reverse the chain.

Adjustment speed depends on construction, permits, finance, specialized assets, and contracts. Short-run profit can persist without contradicting the model if entry takes time. Likewise, firms may remain during temporary losses when exit is costly.