An industry is characterized by positive economic profits. This means that

Question

BlackTom AI · Accepted Answer

When an industry earns positive economic profits, the incentives for entrants become clearer, and market dynamics respond accordingly.
Option 1: 'the industry is in equilibrium.' This statement is typically false in the presence of positive economic profits, because profits above normal induce entry until profits are driven toward zero in the long run, disrupting equilibrium conditions.
Option 2: 'managers in the industry understand economic theory.' While many managers may understand theory, positive economic profits do not imply universal understanding; more importantly, theory unrelated to profit signals is not what directly explains why profits exist, so this option shifts focus away from competitive forces.
Option 3: 'new companies probably will attempt to enter the industry.' This is a classic result in competitive markets: positive economic profits attract entrants, increasing supply and competition, which tends to erode those profits over time. The presence of profits acts as a beacon for new entrants.
Option 4: 'the level of accounting profits is not important.' In fact, accounting profits can be positive even if economic profits are zero or negative, and the existence of positive economic profits is precisely tied to the gap between accounting profits and opportunity costs; ignoring this distinction can mislead about incentives to enter.
Overall, the intuitive logic is that positive economic profits raise the incentive for new firms to enter, which alters market supply and profit levels over time, making entry the natural expectation rather than stagnation or disregarding profits altogether.

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