Question

When business managers of firms in a competitive market observe falling profits, they are likely to infer that the market is characterised by:

A.	a violation of conventional market forces
B.	rising prices
C.	too few firms in the market
D.	over-investment

Answer 1

When business managers of firms in a competitive market observe falling profits, they are likely to infer that the market is characterised by RISING PRICES (B)

Now let us understand each option:

It is not (A) because there is no volition of conventional market forces.Under perfect competition, firms can only experience profits or losses in the short run. In the long run, profits and losses are eliminated by an infinite number of firms producing infinitely divisible, homogeneous products.

It will be (B) because In a competitive market, when there are falling profits or firms are incurring losses, it will cause some firms to exit the market, and leading to rise in prices.

(C) Option C is incorrect because falling profits means many firms in the market. As new firms enter, the supply curve shifts to the right, leading to fall in prices and in-turn fall in profits. Firms continue to enter the industry until economic profits fall to zero.

(D) Over Investment is not an option as in perfect competition, every firm is considered both allocatively and productively efficient.