Explain in economic terms all of the pieces of the equation

Explain, in economic terms, all of the pieces of the equation P=MC=Minimum ATC. Why does this equation exist? Why does it work? Why is the result the most efficient?

Solution

P represents price of the good.

MC is marginal cost, which is the cost of producing the last additional unit.

Minimum ATC is the lowest point of the U-shaped average total cost curve.

This equation represents the long run equilibrium of a perfectly competitive market where, in the long run, a price-taker firm produces at the lowest point of his ATC curve, therefore earning zero excess profits.

This is the example of maximum efficiency because the firm is operating at the lowest possible total cost.

This condition works because, being attracted by existing firms\' short run excess profits, other firms enter the market (since entry is free), which reduces demand of existing firms, eroding their profit. The process continues until price is equated with the lowest ATC resulting in zero excess profit.