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Competitive Firms

Imagine you run a lemonade stand in Lemonville, a town with thousands of competing lemonade stands.

Each lemonade stand sells the same thing: lemonade.

A competitive market is one with many firms who sell (nearly) identical products.

And... consumers really don't care which lemonade stand they go to... they just want lemonade.

Consumers, in-turn, are relatively indifferent to which firm's product they purchase.

Being that there's so many lemonade stands in Lemonville...

Each firm in a competitive market is a price taker.

There are so many companies in a competitive market. In addition, they produce extremely similar products.

This results in one single firm not having much market power!

Think about it: if you decide to hike up the price of your lemonade, but all the other lemonade stands in Crammerville keep their prices the same... customers are just going to go to a different stand than yours! And you'll go outta business!

This displays a lack of market power, and is the reason why firms in a competitive market must take the price that the market has set (based on supply and demand).

In addition, it's not too tough to enter or exit the market. It doesn't take too much to build a lemonade stand!

There are low barriers of entry in a competitive market. It's easy to enter or exit!

Do competitive firms make profit?

Let's imagine that for a month, the lemonade stands in Lemonville begin to rake in loads of economic profit.

Considering the factors above (especially easy entry or exit of the market), whenever a competitive market has its firms profiting economically... it results in more firms entering the market!

Why?

Because there's low barriers of entry- all they need to do is set up a lemonade stand and start making profit!

If firms in a competitive marketplace are making profit in the short-term, more firms will join the market.

However... this profit won't last forever. As more and more firms enter the market, in the long-run it results in profit equaling zero.

How so?

Because when new firms enter the market, they start eating away at the available demand... until eventually there's no more extra economic profit to go around! This stops new firms from entering the market.

In the long-run, competitive firms experience zero economic profit.

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