In a competitive market with identical firms, what happens to the long-run economic profit of each firm?

• A. It becomes zero due to free entry and exit.
• B. It fluctuates unpredictably due to market forces.
• C. It remains positive because firms can set prices above marginal cost.
• D. It becomes negative as competition increases.

Answer: (A)

Verified step by step guidance

1. Understand the concept of long-run equilibrium in a perfectly competitive market, where firms are price takers and produce identical products.
2. Recall that in the long run, free entry and exit of firms occur, meaning that if firms are making positive economic profits, new firms will enter the market, increasing supply and driving down prices.
3. Recognize that if firms are making losses, some will exit the market, reducing supply and causing prices to rise until losses are eliminated.
4. Use the condition for long-run equilibrium where economic profit equals zero, which happens when price equals the minimum average total cost (P = ATC), ensuring no incentive for entry or exit.
5. Conclude that due to free entry and exit, the long-run economic profit of each firm in a competitive market becomes zero.