Refer to Figure 14-13. If the price is P1 in the short run, what will happen in

Question

Refer to Figure 14-13. If the price is P1 in the short run, what will happen in the long run?

a. Individual firms will earn positive economic profits in the short run, which will entice other firms to enter the industry. b. Because the price is below the firm's average variable costs, the firms will shut down. c. Individual firms will earn negative economic profits in the short run, which will cause some firms to exit the industry. d. Nothing. The price is consistent with zero economic profits, so there is no incentive for firms to enter or exit the industry. Suppose a firm in a competitive industry has the following cost curves: Refer to Figure 14-13. If the price is P1 in the short run, what will happen in the long run? a. Individual firms will earn positive economic profits in the short run, which will entice other firms to enter the industry b. Because the price is below the firm's average variable costs, the firms will shut down. c. Individual firms will earn negative economic profits in the short run, which will cause some firms to exit the industry. d. Nothing. The price is consistent with zero economic profits, so there is no incentive for firms to enter or exit the industry.

Explanation / Answer

Option (a) is correct.

In a competitive industry there is free entry and exit of firms. Since the price P1 is above the average variable cost (AVC), the firm will earn some economic profit in the short run. Such profit encourages other firms to get enter into the industry. It automatically reduces profit in the long run. In the long run a firm can enjoy only normal profit.

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