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A firm in a purely competitive industry has a typical cost structure
A firm in a purely competitive industry has a typical cost structure. The normal rate of profit in the economy is 6 percent. This firm is earning $5.50 on every $50 invested by its founders.
a. What is its percentage rate of return?
b. Is the firm earning an economic profit? If so, how large
c. Will this industry see entry or exit?
d. What will be the rate of return earned by firms in this industry once the industry reaches long-run equilibrium?
Expert Solution
a. The percentage rate of return is $5.5/$50 = 11%. This is the amount of earnings per dollar invested.
b. Yes the firm is earning an economic profit of 11% in the short run.
c. If the rate of profit in the industry (11%) is higher than the normal rate of profit in the economy (6%), there will be entry into the market.
d. In the long run, because the firm is perfectly competitive, entry will occur until the firm earns zero economic profit. If the firm earns zero economic profit the long run rate of return is equal to 0%.
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