Suppose that a normal rate of return in the economy is 10% and the rate of return being earned by firms in a competitive industry equals exactly 10%. Which of the following is a correct prediction based on this information?

Question

Quizplus · Accepted Answer

When firms in a competitive industry earn a rate of return that equals the normal rate of return in the economy (10% in this case), it indicates that they are earning zero economic profit. This is because economic profit takes into account the opportunity cost of capital. If firms are earning exactly the normal rate of return, they are just covering their opportunity costs, including the cost of capital. Therefore, there is no incentive for new firms to enter or for existing firms to expand, as they are not earning above-normal profits. The most likely action firms will take is to invest in maintaining their current capital stock, rather than expanding or contracting.

Suppose That a Normal Rate of Return in the Economy