WHY DO COMPETITIVE FIRMS STAY IN BUSINESS IF THEY MAKE ZERO PROM?

A first, it might seem odd that competitive firms earn zero profit in the long run. After all, people start  make a profit. If entry eventually drives profit to zero, there might seem to be little reason to  in business.

Figure 7 . Long-Run Market Supply

Consider an example. Suppose that a farmer had to invest $1 million to open his farm, which otherwise he could have deposited in a bank to earn $50,000 a year in interest. In addition, he had to give up another job that would have paid him $30,000 a year. Then the fawner’s opportunity cost of farming includes both the interest he could have earned and the forgone wages-a total of $80,000: Even if his profit is driven to zero, his revenue from farming compensates him for these opportunity costs.

Keep in mind that accountants and ‘economists measure costs differently. As we discussed in the previous chapter, accountants keep track of explicit costs but not implicit costs. That is, way measure costs that require an outflow of money from the firm, but they do not include the opportunity costs of production that do not involve an outflow of money. As a result, in the zero-profit equilibrium, economic profit is zero, but accounting profit is positive. Our farmer’s accountant, for instance, would conclude that the farmer earned an accounting profit of $80,000, which is enough to keep the farmer in business.

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