At the current short-run market price, firms will earn economic profits, break even, or incur losses in the short run. In the long run, what will happen in a perfectly competitive market?

• A. Firms will be forced to shut down due to persistent losses.
• B. Firms will earn zero economic profit as entry and exit drive the market to equilibrium.
• C. Firms will always earn negative economic profit in the long run.
• D. Firms will continue to earn positive economic profit indefinitely.

Answer: (B)

Verified step by step guidance

1. Understand the concept of economic profit: Economic profit is the difference between total revenue and total costs, including both explicit and implicit costs. Positive economic profit attracts new firms, while negative economic profit causes firms to exit the market.
2. Recall the characteristics of a perfectly competitive market: Many firms, identical products, free entry and exit, and firms are price takers. These conditions ensure that no single firm can influence the market price.
3. Analyze the short-run scenario: If firms are earning positive economic profits, this signals other firms to enter the market, increasing supply and driving the price down. Conversely, if firms incur losses, some will exit, reducing supply and pushing the price up.
4. Explain the long-run adjustment process: Entry and exit of firms continue until economic profits are zero. At this point, firms earn just enough to cover all their costs, including opportunity costs, and no incentive exists for firms to enter or exit.
5. Conclude that in the long run, the market reaches equilibrium where firms earn zero economic profit, meaning they break even economically, and the market price equals the minimum point of the average total cost curve.