Question

What are economic profits? Does a firm in a competitive industry earn long-run economic profits? Explain.

Answer 1

Economic profit is the difference between gross monetary revenue and total cost, but overall costs include overt as well as implied costs. Economic income involves the production-related opportunity costs, and is thus smaller than accounting profit. Economic income also reflects a longer time cycle than accounting profit. Economists also see long-term economic benefit as determining if a business can enter or leave a market.

Economic profit can be positive, zero, or negative. If the economic benefit is good, there is an opportunity for other firms to enter the market. If profit is nil, there is no incentive for other firms to enter or exit. When economic profit is zero, a firm earns the same as it would if it employed its resources in the next best alternative. If the economic benefit is low, companies are given the opportunity to exit the market because otherwise their money will be more competitive. The amount of economic income that a company receives depends primarily on the degree of market competition and the time period that is being considered.

Price will adjust to reflect any changes in cost of production we observe. In the short run, a change in variable cost causes prices to change. Any change in the average total cost changes prices by an equal amount over the long term. In a competitive market the message of long-run equilibrium is a profound one. Consumers are the ultimate beneficiaries of the companies' innovative efforts. In the long run, businesses in a perfectly competitive world gain zero profit. Although businesses can earn long-term accounting income, they can not achieve economic benefits.