Question

A perfectly competitive industry with constant costs initially operates in long-run equilibrium. When demand increases: A. in the long and short runs, prices and profits will be lower relative to what they were before the demand increase. B. in the short run, prices and profits will be higher, but in the long run, price will fall back to its original level and firms will again earn zero economic profit. C. in the short run, prices and profits will fall, but in the long run, price will rise back to its initial level, as will profits. D. in the long and short runs, prices and profits will be higher relative to what they were before the demand increase.

Answer 1

A perfectly competitive industry with constant costs initially operates in the long run equilibrium.When demand increases then, in the short run , prices and profiits will be higher but in the long run ,price will fall back to its original level and firms will again earn zero economic profit.

Because initially in the long run equilibrium, when demand increases ,demand curve shifts to the right and price will lie above ATC and thereore in the short run there will be higher economic profit . But in the long run , there will be new entry of firms because of positive economic profit .As a result , price will fall back to the original level i.e P= minimum of ATC. And in the long run firms will again earn zero economic profit.

Hence, option (B) is correct.