Question

Suppose that a firm is earning a 12% return on capital in a perfectly competitive industry, and the market return outside the industry is 9.5%. Which of the following statements is TRUE?

Correct answer- In the long run, the firm's return on capital will be 9.5%.

Please explain how they go to this correct answer and steps

Answer 1

The perfectly competitive market have free entry and exit so if the firm in the market is earning the economic profit then the new firm will enter the market up to the economic profit is zero and if the firms are earning economic losses then some of the firms will exit the market up to the economic profit is zero.

the economic profit means return higher than the market return and the zero economic profit means return equal to the market.

here, the firms in the market are earning the economic profit because the return is higher than the market and so new firms will enter the industry up to the return is equal to market return means the 9.5% of the return.