Question

If a purely competitive constant-cost industry is realizing economic profits, what will happen in the long run?

1) Firms will enter the industry, increasing supply and driving down prices
2) Firms will exit the industry, decreasing supply and driving up prices
3) The industry will remain in equilibrium with no changes in supply or prices
4) The government will intervene to regulate the industry

Answer 1

A purely competitive constant-cost industry realizing economic profits will attract new firms, leading to increased supply and reduced prices until long-run equilibrium is reached and profits become normal (zero economic profit).

Step-by-step explanation:

If a purely competitive constant-cost industry is realizing economic profits, in the long run, it will experience a change in the number of firms in the market. Specifically, the economic profits will attract new firms to enter the industry, leading to an increase in supply. As more firms enter the industry and supply increases, the price will be driven down. According to the principles of perfect competition, this will continue until the economic profits are eliminated and firms earn only normal profits. This is the point where the price equals the average cost (AC) of production, and it is here that the industry will reach a long-run equilibrium. The adjusted supply will ensure that no new firms want to enter and existing firms do not want to leave the market.