Answer to Question #210549 in Microeconomics for Maria

Question

What is the point of entering a perfectly competitive industry if it is simply to earn zero profits anyway?" Discuss this statement with reference to the long and short run, as well as to heterogeneity across firms. 

Answer 1

Solution:

The reason why a perfectly competitive industry is attractive to many firms despite earning zero profits is because of the many excellent features it has. These features include free entry and exit, cheap and efficient means of trading, a large number of buyers, all firms produce homogenous goods, a wide extent, and the existence of perfect knowledge. This makes it easy for firms to operate with fewer hassles and disruptions. It is also easy for new firms to establish themselves in the market and be successful.

 

In the short run, it is possible for firms in a perfectly competitive industry to make economic profits or losses. The firms will be making economic profits when the price is higher than the average total cost and losses will be made when the price is lower than the average total cost.

In the long run, economic profit cannot be sustained and firms will earn zero profits as a result of the elimination of profits and losses since more firms will enter the market producing similar homogenous products. The demand of each individual firm will shift downwards, bringing down the price, the average revenue, and marginal revenue curve and Its horizontal demand curve will touch its average total cost curve at its lowest point.