If an industry earns a return on capital in excess of its cost of capital,
A)incumbents will earn abnormal profit, and build entry barriers.
B)the government needs to make sure that competition will increase.
C)it is likely to attract the attention of firms looking to enter the industry, which may eventually lead to the return on capital falling.
D)it will attract firms outside the industry, but the incumbents will have erected entry barriers.

Question

Quizplus · Accepted Answer

An industry earning a return on capital in excess of its cost of capital is likely to attract firms looking to enter the industry, which may eventually lead to the return on capital falling. This is because the excess profits signal that there is an opportunity for firms to earn higher profits which will attract new entrants into the industry. As the number of firms in the industry increases, competition will increase, which will drive down profits to a normal level. Therefore, the correct answer is C.

If an Industry Earns a Return on Capital in Excess