“The law is the survival of the fittest…. The law is not the survival of the ‘better’ or the ‘stronger,’ if we give to those words any thing like their ordinary meanings. It is the survival of those which are constitutionally fittest to thrive under the conditions in which they are placed; and very often that which, humanly speaking, is inferiority, causes the survival.” €• Herbert Spencer
At any given time, there may be firms of varying sizes and efficiency in an industry, possibly some making profits and others incurring losses. As long as industry is open for anyone to enter freely, an excess of price over the attainable average total costs will encourage the entry of new firms. As such new firms move in, they compete with existing firms and the most inefficient firms are eliminated. In the long-run, therefore, only those firms will remain in the industry, which have the lowest average total costs, as low as those, which would be incurred by new enterprises in optimal scale adjustments. If a long-run equilibrium position is finally attained, there might still be many differences between firms but the lowest average total costs of all firms would be the same. For instance, some entrepreneurs may be more efficient than others, some firms may be located near markets and may be paying higher rents whereas others are more distant and may be paying lower rents. Again, some firms may be small with close personal supervision and hence with greater efficiency whereas others may be large and with mass production methods. In view of these differences, the firms may not be having identical or similar cost curves. Still, each firm must produce at an average cost as low as that of its competitors. In other words, though there may be differences between firms, these may be balanced by balancing advantages and disadvantages giving rise to uniformity of minimum average total costs.
To illustrate, two manufacturers of cotton textiles may be differently located; one may have the advantage of nearness to buyers but the disadvantage of higher rent. The other may be located away from the buyers and as such may have the advantage of lower rent but the disadvantage of higher transport costs. Here the advantages and disadvantages may balance so that the two firms have the same lowest average costs. Another example is that of one firm having a more efficient manager than the other. Here the efficient firm may have the advantage of higher productivity but disadvantage of higher salary payments as compared to the less efficient firm. On balance, the two firms may have the same lowest average costs.
In an industry adjustments towards long-run equilibrium do not necessarily take place smoothly. In fact, too many firms may enter a profitable industry. Thus, by the time they are turning out finished products, market price may drop below costs. As a result, firms may start withdrawing from the industry so much so that too many firms withdraw with opposite effects. This is most likely to occur where initial investments are relatively small or where given fixed equipment can be utilized in other industries. This is because these conditions facilitate quick entry as well as withdrawal. Agriculture provides an example of this type where the same fixed assets can be utilized alternatively as, for example, either for producing wheat or rice,or jute or cotton.