Question

4. Explain what happens in the long run when firms in an industry are earning positive profit, and why economists assume normal profit in competitive industries is 0. 5. Explain price discrimination and how it can increase efficiency.

Answer 1

Ans) 1) Perfectly competitive market is where there are many sellers selling homogeneous products. Firms are price takers and price is equal to marginal revenue.

A profit maximising competitive firm produces the quantity where MR and MC curve intersect.

If price is above ATC, firms earn positive economic profit. And seeing this profit ,more firms enter the market. This increases supply and price decreases. Price decreases till it reaches minimum of ATC where firms earn zero economic profit.

Firms in competitive markets always earn zero economic profit due to ease of entry and exit. Firms enter and exit till there is no incentive to enter or leave the market i.e when P = ATC and firms are earning zero economic profit.

Zero economic profit are also known as normal profit as these profits are sufficient just to sustain in the market. And if they are earning below this then they should leave the market. As they might get better opportunities elsewhere.

2) Price discrimination is the practice of charging different price for same product from different people, groups etc.

Price discrimination helps the producers to capture larger market share by adjusting the price according to the willingness to pay.

Perfect price discrimination helps the sellers to charge each person differently according to their willingness to pay. This helps producers to capture all the consumer surplus. Further there is no deadweightloss. Since there is no deadweightloss, total surplus is maximised (however there is no consumer surplus.)