Explain how a profit can be earned in the short run but not the long run in a perfectly competitive market.

This is a fairly common a) question on Economics HL paper one. It is a 10 mark question, so a maximum of 20 minutes should be spent on it in order to leave time for question b). It concerns the workings of the market structure perfect competition. In order to obtain as many marks as possible, the 10 mark answer should be structured as follows.

First, you should be defining the key terms in the question. In this question there are two key concepts you are expected to define in order to pick up marks, namely defining perfect competition, and distinguishing between the short and the long run.

Perfect Competition is a market structure in which many assumptions are made, ie that there are an infinite amount of firms and buyers, that they produce identical products, there are no barriers to entry, there is perfect knowledge between firms and that there is perfect mobility of factors of production. These factors define the key feature of Perfect Competition which is the flat or perfectly elastic demand curve, which you will have to use later, although you don't need to include this part in your definition.

Distinguishing between the short and long run is simple. In the long run, there are no fixed factors of production, whilst in the short there are both fixed and variable factors.

You should now proceed to answer the question. You should first answer how it is possible to make a profit in the short run. This will be a little bit difficult to show without diagrams, which your answer obviously must include. You should start with an example, eg the market for wheat. The market for wheat should be a typical perfect competition diagram at first, where the flat Demand=Marginal Revenue= Average Revenue curve is equal to your marginal cost curve in order to satisfy profit maximization, whilst the Average total cost curve, a parabola should touch the same point so that the D=MR=AR curve is at a tangent with it.

Then proceed to come up with a scenario which may shift the demand curve, ie a world covering news report reveals the extraordinary health benefits of wheat. This causes demand to shift upwards as people seek to take advantage of these health benefits, so that it is not at a tangent anymore with Average Total Cost, but instead crosses it at two points. You can then proceed to show the profit, by taking the new MC=MR, and drawing a line vertically until it meets the Average total cost curve, and then take MC=MR and this point and jot horizontal lines onto the price axis. This box represents your profit.

Now you will show why this is not possible in the long run. In the long run, no factors are fixed, and in perfect competition there are also no barriers to entry. This means that in the long run, firms can come into the market for wheat as they identify the opportunity for profit. This pushes the individual firms demand back down to its original position where MC=MR=the lowest point of the ATC, where no profit is possible. Therefore the reason why a profit isn't possible in the long run is due to the non-existent barriers to entry in perfect competition, as well as the other factors given in the definition.

This answer can also be accompanied by a diagram showcasing the shifts in demand and supply of the actual market to show the shifts in demand for the original firm, although this may prove difficult under timed pressure.