The theory of perfect competition explicitly assumes that there are no entry or exit barriers to new participants in an industry. With free entry, positive economic profits induce new entrants. As these firms enter, the supply curve shifts to the right, causing a fall in the equilibrium price of the product. Entry will stop, and equilibrium will be achieved, when economic profits have fallen to zero.
The theory of perfect competition explicitly assumes that there are no entry or exit barriers to new participants in an industry. With free entry, positive economic profits induce new entrants. As these firms enter, the supply curve shifts to the right, causing a fall in the equilibrium price of the product. Entry will stop, and equilibrium will be achieved, when economic profits have fallen to zero.
Some firms may earn greater accounting profits than others because, for example, they own a superior source of an important input, but their economic profits will be the same.
To be more concrete, suppose one firm can mine a critical input for $2 per pound while all other firms in the industry have to pay $3 per pound. The one firm will have an accounting cost advantage and will report higher accounting profits than other firms in the industry. But there is an opportunity cost associated with the company’s input use, because other firms would be willing to pay up to $3 per pound to buy the input from the firm with the superior mine.
Therefore, the company should include a $1 per pound opportunity cost for using its own input rather than selling it to other firms. Then, that firm’s economic costs and economic profit will be the same as all the other firms in the industry. So all firms will earn zero economic profit in the long run.
The theory of perfect competition explicitly assumes that there are no entry or exit barriers to new participants in an industry. With free entry, positive economic profits induce new entrants. As these firms enter, the supply curve shifts to the right, causing a fall in the equilibrium price of the product. Entry will stop, and equilibrium will be achieved, when economic profits have fallen to zero.
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ReplyDeleteThe theory of perfect competition explicitly assumes that there are no entry or exit barriers to new participants in an industry. With free entry, positive economic profits induce new entrants. As these firms enter, the supply curve shifts to the right, causing a fall in the equilibrium price of the product. Entry will stop, and equilibrium will be achieved, when economic profits have fallen to zero.
Some firms may earn greater accounting profits than others because, for example, they own a superior source of an important input, but their economic profits will be the same.
To be more concrete, suppose one firm can mine a critical input for $2 per pound while all other firms in the industry have to pay $3 per pound. The one firm will have an accounting cost advantage and will report higher accounting profits than other firms in the industry. But there is an opportunity cost associated with the company’s input use, because other firms would be willing to pay up to $3 per pound to buy the input from the firm with the superior mine.
Therefore, the company should include a $1 per pound opportunity cost for using its own input rather than selling it to other firms. Then, that firm’s economic costs and economic profit will be the same as all the other firms in the industry. So all firms will earn zero economic profit in the long run.