ECO 6150 CMU New Firms and Co

In perfectly competitive markets long-term economic profit is zero. If so, why firms bother to enter such a market?

PROFESSOR’S GUIDANCE FOR THIS WEEK’S LE:

In a perfectly competitive market, there are no barriers to entry and firms can enter and leave the market depending on their profits.

1. Please make sure that you read the relevant chapter from the textbook

2. Watch the YouTube videos for this week and additional course material provide

NOTE:

  1. post your 300-400 word
  2. Offer at least two 100-200 word comments (replies) to posts from your peers’ discussions

by Henry Nwosu

In perfectly competitive markets long-term economic profit is zero. If so, why firms bother to enter such a market?

In general, the way to define profits is in terms of what economists refer to as economic profits. Economic profits are the difference between the total revenue and the total opportunity cost of producing the firm’s goods or services (Michael & Jeff, 2016). Therefore, using a resource includes both the explicit cost of the resources and the implicit cost of giving up the best alternative use of the resources.

Zero economic profit does not take opportunity costs into account. All factors of production are variable in the long run. Also, two of the firms’ assumptions in perfect competition are free entry and exit and excellent resource mobility.
Firms making an abnormal profit will attract new firms in the long run, enters freely due to the two assumptions already stated, which will increase the industry supply (and shift the supply curve to the right), decreasing price in the industry (Adam, 2021).

Once existing firms make zero economic profit, new firms will stop entering the market.
Firms making losses in the long run (producing under the break-even price) will exit the market due to not competing with other firms, decreases supply in the industry (and shifts the supply curve to the left), which increases price in the industry.
Industries will exit until the remaining ones make an average profit again. So, therefore, in the long run, all firms in perfect competition earn an average yield (or zero economic profit) (Biglaiser & DeGraba, 2001).

In conclusion, economic profits attract entry, economic losses lead to an exit, and in long-run equilibrium, industries in a perfectly competitive industry will earn zero economic profit. It will induce entry or exit in the long run so that price will change enough to leave firms making zero economic profit.

References

Adam Hayes, (2021). Investopedia, Corporate Finance & Accounting. Retrieved from https://www.investopedia.com/terms/f/fixedcost.asp#:~:text=What%20Is%20a%20Fixed%20Cost,of%20any%20specific%20business%20activities.

Biglaiser, Gary and DeGraba, Patrick, (2001). “Downstream Integration by a Bottleneck Input Supplier Whose Regulated Wholesale Prices Are above Costs.” RAND Journal of Economics 32(2), pp. 302–15.

Michael R. Baye & Jeff Prince, (2016). Managerial Economics & Business Strategy, 9th ed. McGraw-Hill Irwin

by Oluwole Adunbarin

Perfect competition is a theoretical market structure that produces the best possible economic outcomes for consumers and society in a neoclassical economics theory. Neoclassical economic theory is an economic theory that focuses on supply and demand as the driving forces behind the production, pricing, and consumption of goods and services. (Hall, 2020).

In the long run, a firm is free to adjust all its inputs. New firms can enter any market; existing firms can also leave their markets because there is a free entry and free exit in a perfectly competitive market. Therefore, production takes place at the lowest possible cost per unit at long-run equilibrium, and all economic profits and losses are eliminated (Michael, & Jeff, 2016).

Economic profits in a particular industry attract new firms to the industry in the long run. As new firms enter, the supply curve shifts to the right, price falls, and profits fall. Firms continue to enter the industry until economic profits fall to zero. If firms in an industry are experiencing economic losses, some will leave. The supply curve shifts to the left, increasing the price and reducing losses. Firms continue to leave until the remaining firms no longer suffer losses until economic profits are zero (Michael, & Jeff, 2016).

Note, economic profit equals total revenue minus total cost, where cost is measured in the economic sense as opportunity cost. An economic loss (negative economic profit) is incurred if the total cost exceeds total revenue. In comparison, Accountants include only explicit costs in their computation of total cost. Explicit costs include charges that must be paid for factors of production such as labor and capital, together with an estimate of depreciation. Profit computed using only explicit costs is called accounting profit. Just as entry eliminates economic profits in the long run, exit eliminates economic losses (Kenton, 2020).

Reference:

Hall, M. (2020). Why Are There No Profits in a Perfectly Competitive Market? Retrieved from: https://www.investopedia.com/ask/answers/031815/why-are-there-no-profits-perfectly-competitive-market.asp

Kenton, W. (2020). Neoclassical Economics. Retrieved from: https://www.investopedia.com/terms/n/neoclassical.asp

Michael, R. B. & Jeff, P. (2016). Managerial Economics & Business Strategy, 9th ed. McGraw-Hill Irwin, ISBN: 978-1259290619

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