Final answer:
When firms in a perfectly competitive market earn profits, new firms are attracted to the market, causing the supply to increase and driving profits down to zero, establishing a long-run equilibrium. Alternatively, losses will result in firms exiting the market, which adjust supply and can help the remaining firms reach the break-even point.
Step-by-step explanation:
In a perfectly competitive market, if firms start to earn profits, this signals potential entrants that there is money to be made. Over time, new firms will enter the market, drawn by the economic profits. As supply increases due to the entrance of new firms, the market price will begin to fall. Eventually, the market will reach a long-run equilibrium when the economic profits are driven down to zero. At this point, no new firms will enter, and no existing firms will want to leave the market.
Should a firm in a perfectly competitive market face losses, it will either need to adjust its production to reduce costs or exit the market if it cannot be profitable. When firms exit, the market supply decreases, which can lead to an increase in market price, helping remaining firms to eventually break-even or earn normal profits. Again, the objective is to find that balance where economic profits equal zero, signifying a long-run equilibrium state.