How Economic Profit Attracts Entry in Competitive Markets

More firms increase market supply and lower price.

Compare Three Entry and Exit Cases

The cases use an identical-firm competitive model with free entry and exit, unchanged technology and industry input prices, and a lasting demand shift. Each firm takes market price as given. Entry requires an attractive expected economic return for a prospective entrant; an incumbent’s past accounting profit alone is not enough. The short run allows output changes before seller count adjusts.

Follow the Profit-to-Entry Chain

Starting from long-run equilibrium, a lasting demand increase raises price in the stated model. Existing firms expand along unchanged MC curves and earn economic profit. New sellers then add supply, reducing price and the profit gap. With unchanged identical-firm costs and free entry, the endpoint covers normal returns but offers no excess economic profit. The process does not assign an individual firm control over price.

Separate a Supply Shift from Movement Along MC

Entry is an industry event. It does not shift market demand or one incumbent’s cost curve in the constant-cost benchmark. It adds entire firm supply schedules at every market price. The lower market price then moves each incumbent to a smaller output along its own MC.

Use Economic Rather Than Accounting Profit

Economic profit measures the excess after relevant opportunity costs. A positive accounting profit may still fall short of the owner’s next alternative. For an entry decision, compare expected future revenues and avoidable economic costs, including normal risk-adjusted returns, rather than treating sunk spending or an incumbent’s unusually good past year as a promise about a new business.

Keep Loss, Shutdown and Exit Separate

Persistent economic losses can induce exit. With demand and survivors’ costs held fixed, removing sellers shifts market supply left, raising price and reducing the remaining firms’ losses. Some firms can continue operating during the short run when revenue covers variable cost; deciding to shut down for a period and deciding to leave the industry are different comparisons.

Read the Adjustment Reference Table

Compare Incumbent and Industry Output

Demand rises and price increases. An incumbent expands from 50 to 65 units and earns profit. Entry later lowers price, and the incumbent returns to 50 units. Market output remains above its original level because more firms now each produce 50. Firm and industry directions differ during adjustment.

Exit is not the same as every firm reducing output. A lower price initially makes a surviving firm contract along MC. Removing some sellers later changes market supply and the price faced by the survivors. Under the constant-cost assumptions, the long-run zero-profit price can return to the original level; a particular amount of reversal is not a universal result for every cost-changing industry.

State What the Time Horizon Allows

The model does not specify a fixed number of days or months. Actual entry depends on construction time, information, financing and other constraints. Barriers can also prevent the free-entry benchmark from applying. Temporary profit is compatible with an adjustment still in progress; it does not establish that every entrant will succeed or that every market must reach zero profit.

Hold the Right Conditions Fixed

Hold demand and relevant costs fixed while isolating the entry response. If demand shifts again or industry growth changes input prices, recalculate the endpoint instead of reusing the old one. This is an explicit analytical assumption, not a claim that an unspecified exam question always supplies it.

Explain Every Link in the Chain

State the full chain for the specified constant-cost case: economic profit makes entry attractive, seller count rises, market supply shifts right, price falls, each identical incumbent reduces output along MC, and the excess-profit gap closes. If costs or barriers differ, identify the altered link rather than applying the sequence mechanically.

Check the Opportunity Cost Numerically

Consider a separate bookkeeping example: expected revenue of $10,000 minus $9,000 explicit costs leaves $1,000 accounting profit. If the relevant forgone earnings and capital return total $1,200, expected economic profit is −$200. The positive accounting figure therefore does not establish an entry incentive. These are hypothetical values, not a forecast for a real business.

Recognize When Industry Costs Change

If expansion bids up a scarce specialized input, firms’ cost curves may shift and the industry is increasing cost over that range. If shared supplier improvements reduce input costs, the industry may instead be decreasing cost. The unchanged-cost example here isolates seller-count adjustment; do not infer constant costs merely from the word “entry.”

Read the Entry and Exit Explanation

OpenStax’s long-run entry and exit lesson discusses the profit incentive and the distinction between short-run operation and long-run exit. The following cost function, demand equations and questions are original examples, not copied textbook exercises.

Calculate the Arrival of New Sellers

Each identical firm has total economic cost TC = 0.2q² + 500 and MC = 0.4q. The $500 is unavoidable during the short-run operating period but avoidable on long-run exit. For positive q, ATC = 0.2q + 500/q, with a minimum of $20 at q = 50: ATC − 20 = 0.2(q − 50)²/q.

Initial demand is Q = 1,000 − 25P. Ten firms each producing fifty units supply Q = 500 at P = $20 and earn zero economic profit. Demand now shifts permanently to Q = 1,300 − 25P. Costs stay unchanged as sellers enter. At any relevant price, each operating firm chooses q = 2.5P, so n identical firms supply Q = 2.5nP. The market-clearing price is P = 1,300/(25 + 2.5n).

Before entry, P = $26 gives q = 65. One firm’s revenue is $1,690 and cost is 0.2(65²) + 500 = $1,345, so economic profit is $345. With twelve firms, exact price is 260/11, firm output is 650/11, industry output is 7,800/11 and profit per firm is 24,000/121; the table rounds those intermediate values to two decimals. Profit is still positive, so this stage is not the free-entry endpoint.

At sixteen firms, price is $20, each firm produces fifty and total output is 800. Revenue and cost per firm both equal $1,000. During entry, industry output rises from 650 to 800 while each incumbent’s output falls from 65 to 50. Compared with the original equilibrium before demand increased, firm output is unchanged and market output has risen from 500 to 800.

Run the Reverse Exit Comparison

Return to the original ten-firm equilibrium, then instead reduce demand to Q = 750 − 25P. How can firms operate at a loss before exit adjusts seller count?

Try Three Entry Questions

Connect Entry with the Long-Run Benchmark

Compare the conditions for long-run competitive equilibrium, check industry-wide cost changes, or continue with the CLEP Microeconomics learning hub.