Question

part 1

In four paragraphs. Explain why economic profit leads to more firms entering the market. As more and more firms do enter, supply increases, and therefore, the economic profit would continue to increase - do you agree or disagree with this and explain why?

Answer 1

When there is economic profit, firms have an incentive to enter the market. They are driven by profit motives.

In case of perfect competition, the market has no barriers to entry. So when there is economic profit in the market, new firms enter and in turn they increase the supply in the market. This shifts the supply curve to the right and there is a fall in the equilibrium prices and thus a decrease in the revenue of each firm. Thus the economic profit falls.

Thus as more and more firms enter the market, the supply increases and the economic profit decreases.

The industry is the price maker and the firm is the price taker. When the price is P, the firm makes an economic profit as price is greater than average total cost. This induces new firms to enter the market.

When new firms enter the market, supply curve shifts to the right and thus reduces the price. Firms being price taker abide by that price. When price falls, price becomes equal to ATC and thus economic profit becomes zero in the long run.