Suppose a profit-maximising firm in a competitive market is experiencing economic losses in the short-run, what will likely happen next?

Question

BlackTom AI · Accepted Answer

In perfect competition, entry and exit of firms drive long-run economic profits to zero.

1. Relevant knowledge points and concepts
- Price takers: competitive firms accept the market price.
- Economic profit (π) = (P − ATC) × Q. If P < ATC, the firm incurs an economic loss.
- Short-run vs long-run: in the short run firms may earn profits or losses; in the long run, free entry and exit push firms to zero economic profit (normal profit).
- Shutdown rule: if P < AVC, a firm will cease production in the short run; otherwise it may produce while losses persist.

2. Step-by-step reasoning
- A profit-maximising firm facing losses has P < ATC. It still maximises profit (or minimises loss) by producing where MR (= P) = MC, provided P ≥ AVC; if P < AVC it shuts down immediately.
- Losses across the industry signal some firms are unprofitable. Over time, some firms will exit the industry (either by shutting down permanently or reallocating resources).
- Exiting firms reduce industry supply. The industry supply curve shifts leftward, raising the market equilibrium price.
- As price rises, remaining firms’ revenues increase and losses shrink. Exit continues until price equals the minimum point of ATC for firms in the industry.

3. Intermediate steps / algebraic relation
- π = (P − ATC)Q. Initially P < ATC ⇒ π < 0.
- After exit, supply ↓ ⇒ P increases to P′. Long-run equilibrium when P′ = min ATC ⇒ π′ = (P′ − ATC)Q = 0.

4. Why the correct answer is correct
- The mechanism of entry/exit in a competitive market ensures that losses induce exit, supply falls, price rises, and surviving firms earn zero economic profit (normal profit) in the long run.

5. Why other options are incorrect
- Option 1 (earn economic profits): incorrect because exit continues only until economic profits are driven to zero, not to sustained positive profits.
- Option 3 (continue to suffer losses): incorrect because free exit prevents persistent long-run losses; supply adjusts.
- Option 4 (lower price to gain market share): incorrect because firms are price takers and cannot unilaterally lower price to increase market share profitably; lowering price would worsen losses.

6. Conclusion
- Therefore, some firms will leave the industry and the existing firms will earn normal profits in the long run. This matches the provided correct answer.

Suppose a profit-maximising firm in a competitive market is experiencing economic losses in the short-run, what will likely happen next?单项选择题

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