IAI Actuarial Core Principles · Business Economics · Profit maximisation under perfect competition and monopoly
In a perfectly competitive industry in long-run equilibrium, demand then rises permanently. Which sequence best describes the adjustment for a typical firm?
Higher demand raises price and creates supernormal profit in the short run. Free entry draws in new firms, shifting industry supply right and pushing price back down to the minimum of long-run average cost, where firms earn only normal profit again.
- APrice rises, firms earn supernormal profit, new firms enter, supply shifts right and price falls back to minimum average costCorrect
- BPrice rises and stays higher because firms can block entry
- CPrice falls first, firms exit, and price then settles above the original level
- DPrice is unchanged and each firm permanently earns supernormal profit
- Firms' average cost curves shift upward permanently and profits stay positive
Explanation
A demand increase raises price above average cost, giving supernormal profit. With free entry, new firms enter and the supply curve shifts right until price returns to minimum long-run average cost and profit is normal. Entry cannot be blocked in perfect competition.
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