Question

Briefly explain the reason for why in a competitive market we expect economic profits to be zero in the long run. Why do firms operate even though they earn zero economic profit?

Answer 1

In a perfectly competitive market, there are very large number of buyers and sellers such that no firm can influence the price of the product. There is free entry and exit of firms hence when there are economic profits in the short run, new firms are attracted which puts pressure on market price to decrease which leads to zero economic profits in the long run Similarly when there are losses, firms are induced to exit and zero profits results in the long run.