Question

Two years ago, a large number of firms entered a market in which existing firms had been earning positive economic profits. By the end of last year, the typical firm in this industry had begun earning negative economic profits. No other events occurred in this market during the past two years.

1. Explain the adjustment process that occurred last year.

2. Predict what adjustments will take place in this market beginning this year, other things being equal.

Answer 1

Given data:

· Two years ago, a large number of firms entered a market in which existing firms had been earning positive economic profits.

· By the end of last year, the typical firm in this industry had begun earning negative economic profits.

· No other events occurred in this market during the past two years.

· Monopoly: A situation, by legal privilege or other agreement, in which solely one party (company, cartel etc.) exclusively provides a particular product or service, dominating that market and generally exerting powerful control over it.

· Monopolistic competition: A market structure in which there is a large number of firms, each having a small proportion of the market share and slightly differentiated products.

· Oligopoly: An economic condition in which a small number of sellers exert control over the market of a commodity.

a) Adjustment process that occurred last year:

Entry of new firms in the markets leads to increase the market the market supply of goods and services. Demand for goods and services remain the same.

An increase in supply results in a decline in the price below minimum average cost, and consequently, the firms start earning negative economic profit.

Thus, the entry of new firms in the market results in negative economic profit,

b) Adjustments will take place in this market beginning this year:

The firms in the industry would start leaving industry due to negative economic profit.

The market supply would increase when firms start leaving the industry.

Reduction in the market tends to increase the prices of goods and services.