Under what market conditions are firms most likely to enter an industry, and under what conditions are they most likely to exit?

• A. Firms are likely to enter when the government imposes taxes and exit when the government offers subsidies.
• B. Firms are likely to enter when prices are below average total cost and exit when prices are above average total cost.
• C. Firms are likely to enter when existing firms are earning economic profits and exit when they are incurring economic losses.
• D. Firms are likely to enter when there are high barriers to entry and exit when there are low barriers to exit.

Answer: (C)

Verified step by step guidance

1. Understand the concept of economic profits and losses: Economic profit occurs when total revenue exceeds total costs (including opportunity costs), while economic loss occurs when total costs exceed total revenue.
2. Recognize that firms are motivated by profit maximization, so they will enter an industry if existing firms are earning economic profits because it signals potential for earning profits.
3. Conversely, firms will exit an industry if existing firms are incurring economic losses, as continuing to operate would mean sustaining losses.
4. Identify that market conditions such as prices relative to average total cost (ATC) influence entry and exit: if price > ATC, firms earn profits; if price < ATC, firms incur losses.
5. Note that barriers to entry and exit affect the speed and ease of these movements but do not change the fundamental incentive driven by economic profits and losses.