A price-taker market tends toward a state of long-run equilibrium in which firms earn only a normal rate of return (zero economic profits) because
A) firms will keep their prices low under fear of government regulation.
B) with firms able to enter and leave the industry freely, competition will drive prices down to the level of production costs.
C) by definition, production costs always rise to equal the market price.
D) mismanagement on the part of owners generally results in the firms not equating marginal revenue and marginal cost.

Question

Quizplus · Accepted Answer

In a price-taker market, firms cannot influence the price of their product and must accept the market price. With firms able to enter and exit the industry freely, competition drives prices down to the level of production costs. Eventually, firms will only earn a normal rate of return (zero economic profits) in the long-run equilibrium. This is because if firms were earning above-normal profits, new firms would enter the industry, increasing supply and driving down prices. If firms were earning below-normal profits, some firms would exit, decreasing supply and driving up prices. This process continues until all firms earn only a normal rate of return.

A Price-Taker Market Tends Toward a State of Long-Run Equilibrium