Refer to Figure 16-3. Which of the following will occur in the long run in this industry?

• A. Firms will earn zero economic profit as entry and exit drive price to average total cost.
• B. Firms will incur persistent losses because price remains below average total cost.
• C. Firms will continue to earn positive economic profit due to barriers to entry.
• D. The number of firms in the industry will decrease as demand increases.

Answer: (A)

Verified step by step guidance

1. Understand the context: The problem refers to a long-run equilibrium in a perfectly competitive industry, where firms can freely enter and exit the market.
2. Recall the key characteristic of long-run equilibrium in perfect competition: Firms earn zero economic profit because the market price equals the minimum point of the average total cost (ATC) curve.
3. Analyze the role of entry and exit: If firms are earning positive economic profits, new firms enter, increasing supply and driving the price down. If firms incur losses, some exit, decreasing supply and driving the price up.
4. Recognize that this process continues until price equals average total cost, eliminating economic profits and losses, which is the hallmark of long-run equilibrium.
5. Conclude that in the long run, the industry reaches a point where firms earn zero economic profit as entry and exit adjust the market price to equal average total cost.