CFA Practice Question

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CFA Practice Question

In the long run, entry will occur in a perfectly competitive market as long as ______

I. economic profits are greater than zero.
II. there are no barriers to entry.
III. demand is increasing.
IV. price is greater than short-run average variable cost.
Correct Answer: I only

Entry occurs as long as economic profits exceed zero, that is, as long as price exceeds average cost.

User Contributed Comments 12

User Comment
isida III and IV are wrong because for perfectly competitive markets, demand = MR = price which is straight line; it can never incerase
bluefin209 I'm pretty sure that demand can increase in a perfectly competitive market. It certainly can decrease, giving rise to the problem of when a firm should shut down. I disagree with this answer.
sunny Well, the increased demand won't necessarily attract new entries, as current players in the market may increase supply. As long as there are positive economic profits, even if the demand is decreasing, there will be new entrants to the market to take advantage of the economic profits. Keep in mind that all these are in the long-run.
AlexYuen the only reason why this ans makes sense are the keywords 'as long as' i.e they are looking for the single most impt factor. in LR or SR, all other ans (except iv) are plausible too (note qn: ENTRY to perfect comp. mkt)
cmisaac the question starts "in the long run ..."
jerylewis as long as Price exceeds ATC right? not AVC?
bobert in response to cmisaac, you do not enter an industry in the short-run. Not enough time.

In response to jerylewis, yes because the way you said it, you would be earning economic profit and therefore firms enter to get a piece of it.

II is wrong because it is not the motivator to enter the market. It is a given that there are no barriers, but they enter to get economic profit, and leave if they are suffering economic losses until it balances out at normal profit.

With regards to III, when demand increases, it shifts the industry demand curve to the right, prices move up, and quantity increases (as described in this lesson) but there is never economic profit to be had.

Remember, in the LONG RUN, ECONOMIC PROFIT is the motivator for entering into the industry. Otherwise there are break even profits (normal profits) or economic losses, in which case firms will be exiting.
bidisha thanks bobert
gill15 Q9 of this section relates to this. From that demand can increase so Isida is wrong. But Q9 also says that if demand increases economic profit does happen and firms enter which makes sense to me. I dont understand why III is wrong here. Goto question 9 and come back here. Im confused
gill15 Read my previous post. Think I got it now. Demand will cause P to increase which THEN will result in Economic Profit and therefor entry will occur just like Q9 says BUT this is not a condition that can continue forever into the future - demand can not just keep increasing.
dmfz If there is incentive in the market because market is profitable, it will drive new firms to enter the market.
linzlinked How can firms make economic profit in perfectly competitively market? Shouldn't be 0?
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