Why economists expect profits in a truly competitive market to vanish
A company can post healthy earnings on its accounts and still, to an economist, make no profit at all. Accountants subtract only the bills a firm actually pays. Economists also subtract implicit costs, such as what the owner's money and time could earn elsewhere. In a perfectly competitive market that fuller measure should eventually shrink to zero.
The logic runs like this. If an industry offers profit beyond all costs, newcomers pour in, provided nothing blocks the door. Their extra supply forces them to undercut on price, and incumbents must follow or lose customers. The squeeze continues until price equals the lowest long-run average cost, at which point there is nothing left to tempt anyone else in and the market settles. That break-even state, where revenue just covers every cost, is called normal profit, the minimum needed to keep a firm going.
Innovation buys only a breather. A company launching a distinctive product may enjoy temporary market power, charging high prices while supply is scarce. Once the product's profitability is obvious and barriers are low, rivals copy it, supply swells and prices fall back toward cost. Lasting profit in a competitive field, once risk is allowed for, tends to reflect relentless cost-cutting that keeps a firm ahead of its competitors.
Persistent profit, by contrast, signals obstacles to competition. Patents, land rights and zoning rules can keep challengers out. Where a few firms dominate, they may collude to restrict output; a monopolist with no close substitutes can set its price almost at will. Because selling more forces it to cut prices on every unit, a monopolist's extra revenue from one more sale is below the price, and it rationally holds output down and prices up.
Governments respond in two ways. Competition law tries to stop dominant firms from building artificial barriers, as in United States v. Microsoft, which ended in a settlement imposing strict oversight. Where competition is impractical, as with a natural monopoly, regulators may instead allow a single supplier but police its prices. The old AT&T needed government approval before raising charges, and officials examined its costs before agreeing.
Source: Profit (economics)
