In a perfectly competitive industry, what is likely to occur when firms are earning economic profit greater than zero?

• A. Existing firms will reduce output to maintain higher prices and profits.
• B. The government will intervene to regulate prices and profits.
• C. New firms will enter the industry, increasing supply and driving profits toward zero.
• D. Firms will exit the industry, reducing supply and increasing profits further.

Answer: (C)

Verified step by step guidance

1. Understand the concept of economic profit in a perfectly competitive market: Economic profit is the difference between total revenue and total cost, including opportunity costs. When economic profit is greater than zero, firms are earning more than their normal profit.
2. Recall the characteristics of a perfectly competitive market: There are many firms, identical products, free entry and exit, and firms are price takers.
3. Analyze the effect of positive economic profits: Positive profits attract new firms to enter the industry because they see an opportunity to earn profits.
4. Consider the impact of new firms entering the market: As new firms enter, the total market supply increases, which shifts the supply curve to the right.
5. Understand the market adjustment: The increase in supply leads to a decrease in the market price, which reduces the economic profits of all firms until profits are driven down to zero, reaching a long-run equilibrium.