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Demand for a good rises, and existing firms in a perfectly competitive market start earning economic profits. According to the source, what happens next as new firms enter?
AExisting firms are barred by law from responding
BSupply shifts right, price falls, profits shrink to zero
CSupply shifts left, price rises further, profits grow
DPrices are fixed by law and never change at all
Answer & Solution
Correct answer: B. Supply shifts right, price falls, profits shrink to zero
1. Economic profits attract new firms into the market, which is the process of entry.
2. As more firms enter and produce, the market supply curve shifts to the right.
3. That rightward shift in supply pushes the market price down.
4. As price falls, economic profits shrink for both new and existing firms, continuing until profits reach zero.
5. Nothing in this process involves a legal price fix or a legal barrier stopping existing firms from responding.
_Source: OpenStax Principles of Microeconomics for AP Courses (CC BY 4.0), Ch 8 "Perfect Competition", section 8.3 | Entry and Exit Decisions in the Long Run_
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