Question

1. "What is the point of entering a perfectly competitive industry if it is simply to earn zero profits anyway?" Discuss this statement with reference to the long and short run, as well as to heterogeneity across firms. (Use appropriate graphs to support your answer).

Answer 1

A perfectly competitive market has homogenous firms, products ad perfect knowledge. It is an extreme and ideal case far from reality. Therefore, the firms are price taker and have no control over the prices. Competition ensures that the most efficient allocation is reached. However, in the process, the profit of each of the firms are driven down to zero in the long run. The following points illustrate why firms join a perfectly competitive industry.

• In the short run, a perfectly competitive industry can earn a super-normal profit. This is demonstrated by the figure below. Economic profit is given by the rectangle.

• There are free entry and exits so in the long run profits are driven down to zero. However, economic profit is not the only source of profit for the producers. The economic profits are what the producers get after deducting the payments to the factors of production, In most of the cases, the firms are also the owners of the factors of production, Therefore, even if economic profit is zero, accounting profit is not zero. Accounting profit = economic profit + earnings from factors of production.
• There is no cost of advertisement or awareness as there is perfect knowledge in the market.