Question

Suppose the firms comprising the supply-side of a perfectly competitive market are earning economic profits, creating the incentive for new firms to enter the market and compete. Which of the following best describes the effect on the market resulting from the entry of new firms?

1) The market supply curve will shift to the right, resulting in a decrease in price and economic profits for all firms.
2) The market supply curve will shift to the left, resulting in an increase in price and economic profits for all firms.
3) The market supply curve will remain unchanged, resulting in no change in price or economic profits for all firms.
4) The market supply curve will shift to the right, resulting in an increase in price and economic profits for all firms.

Answer 1

The entry of new firms in a perfectly competitive market leads to a rightward shift in the market supply curve, causing prices to decrease and economic profits to fall until they reach zero.

Step-by-step explanation:

When firms in a perfectly competitive market are earning economic profits, it creates an incentive for new firms to enter the market. The entry of new firms has a direct effect on the market supply curve, causing it to shift to the right. This increase in supply leads to a decrease in the market price, which, in turn, reduces the economic profits for all firms in the market. The process continues until economic profits reach zero, indicating a long-run equilibrium where no firm is earning economic profits above the normal rate of return.