If all company in a certain industry are earning economic profits now, in long run what will happen?
In the long run, if all companies in a certain industry are earning economic profits, several factors will come into play that will likely lead to a decrease in those profits or the elimination of such profits. This is because economic profits act as a signal for new firms to enter the industry and compete for market share.
Here's how the process usually unfolds:
1. Entry of new firms: The existing companies enjoying economic profits attract new competitors who perceive the opportunity for high returns. These new companies enter the industry, increasing supply and competition.
2. Increase in supply: The entry of new companies increases the overall supply of goods or services in the industry. As a result, the market becomes more saturated, and the existing firms start seeing a decrease in their market share.
3. Decrease in prices: With increased competition and a higher supply of goods or services, prices in the market tend to decrease. This decline in prices reduces the profit margin for each unit sold, impacting the economic profits earned by the companies.
4. Market equilibrium: As prices continue to decrease due to intense competition, it eventually reaches a point where companies are no longer earning economic profits. The market reaches equilibrium, where price equals the average total cost (including both fixed and variable costs) for firms in the industry.
5. Exit or reallocation: Some firms might decide to exit the industry if they can't sustain their operations without economic profits. Others may reallocate their resources to more profitable industries or change their strategies to differentiate themselves and regain a competitive edge.
6. Long-run adjustment: Over time, the entry and exit of firms will continue until economic profits stabilize. This usually leads to a more balanced market with lower profit margins and potentially smaller firms who can operate efficiently at the prevailing market prices.
In summary, in the long run, if all companies in an industry are earning economic profits, the entry of new firms will increase competition, decrease prices, and eventually eliminate those profits. This process helps restore equilibrium in the market and aligns profits with the underlying costs of production.