economic costs include the opportunity cost of capital, if the firms are just
breaking even they are doing as well as they could do by investing their
capital elsewhere. Hence, there will be no incentive for firms to leave the
industry if economic profits are zero. Similarly, if new entrants expect just
to break even, there will be no incentive for firms to enter the industry
because capital can earn the same return elsewhere in the economy. If,
however, the existing firms are earning revenues in excess of all costs,
including the opportunity cost of capital, new capital will eventually enter
the industry to share in these profits. Conversely, if the existing firms are
suffering economic losses, capital will eventually leave the industry
because a better return can be obtained elsewhere in the economy. Let us
now consider this process in a little more detail.
An Entry-Attracting Price
First, suppose there are 100 firms in a competitive industry, all making
positive profits like the firm shown in part (iii) of Figure 9-8. New firms,
attracted by the profitability of existing firms, will enter the industry.
Suppose that in response to the high profits, 20 new firms enter. The
market supply curve that formerly added up the outputs of 100 firms must
now add up the outputs of 120 firms. At any price, more will be supplied
because there are more producers. This entry of new firms into the
industry causes a rightward shift in the industry supply curve.
With an unchanged market demand curve, this rightward shift in the
industry supply curve will reduce the equilibrium price. In order to
maximize profits, both new and old firms will have to adjust their output