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IAI Actuarial Core Principles · Business Economics · Profit maximisation under perfect competition and monopoly

In a perfectly competitive industry with free entry and exit, firms are currently earning supernormal profits. Which sequence best describes the move to long-run equilibrium?

Entry occurs, shifting market supply to the right and pushing price down until economic profit is zero. Supernormal profits attract new firms, and the extra supply lowers price to the level of minimum long-run average cost, where firms earn only normal profit.

  1. AExisting firms raise prices, which increases profit until demand falls
  2. BNew firms enter, market supply shifts right, price falls until economic profit is zeroCorrect
  3. CNew firms enter, market supply shifts left, and price rises until profit is zero
  4. DFirms exit, market supply shifts left, and price rises
  5. Market demand shifts left until price equals average fixed cost

Explanation

Supernormal profit attracts entrants. Entry shifts industry supply right, lowering the market price. This continues until price equals minimum long-run average cost and economic profit is zero. Options with a leftward supply shift describe exit, which happens under losses.

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