The "perfectly competitive market" is an abstract theoretical construction used by economists. It serves as a benchmark to compare existing competition in real markets. Under perfect competition, firms can only experience profits or losses in the short run. In the long run, profits and losses are eliminated by an infinite number of firms producing infinitely divisible, homogeneous products. Firms experience no barriers to entry, and all consumers have perfect information. In other words, all of the possible causes of long-run profits are assumed away during perfect competition.

During perfect competition, every firm is considered both allocatively and productively efficient. Equilibrium will occur at the point where price equals marginal cost (allocative efficiency). Long-run equilibrium will occur where marginal cost equals average total cost (productive efficiency).

Definition of Profits

Economists and accountants distinguish between normal profits and economic profits. Normal profit is defined as revenue less both explicit and implicit expenses. In other words, normal profit allows for businesses to make just enough over cost so they are compensated for their opportunity costs.

An economic profit is anything earned over normal profits. There can be no economic profits in long-run equilibrium, but all firms earn normal profits in the long run. Some textbooks refer to economic profit as "super-normal profit."

What Happens If Super-Normal Profits Are Made?

Some benchmark economic models don't allow for any changes in productive inputs or consumer purchases, such as steady-state equilibrium or the "evenly rotating economy." According to these models, every economic transaction from yesterday is repeated today and will be repeated tomorrow. Note that steady-state equilibrium is not the same as a steady-state economy.

Perfectly competitive markets are not necessarily steady-state. Conditions can change, and firms can earn super-normal profits in the short run.

However, super-normal profits in the short run will attract competitor firms and prices will fall. Similarly, super-normal losses will cause firms to exit the market, and prices will rise. These phenomena will continue until long-run equilibrium is reached. (For related reading, see: Do all economists believe in perfect competition?)