Question

3. If a few "big banks” consistently make more than "normal profits" (i.e. economic profits are greater than a (a) in a free market capitalism setting, what would happen to the number of competitors (banks) in the long How would this impact their profits? (b) If you observed that, over time, their profits haven't fallen, what would likely be the ultimate cause?

Answer 1

a) If few big banks make consistently make more than normal profits in short run. As market is competitive and there is no legal barrier to enter or exit in the market, more new banks would enter into the market after observing banks making huge profits. As more banks enters into the market, the profit that can be absorbed from the market would remains the same, that profit would be divided among more banks now which reduces the profit for all banks in long run. In long run a situation comes when bank starts making normal profit and falling from that level would force banks to leave the market.

b) If the profit haven't fallen of banks even if more banks are joining the market, the reason must be that profit that banks can capture from market are also rising. Due to this reason, when profits are getting divided among the banks, profit per bank is not falling.