Under the competition principle, with feasible entry and other conditions unchanged, unusually high expected profits tend to create which incentive?
Correct Answer
B) Entry and added supply that can put pressure on returns
Above-normal expected profits can attract new supply and competition when entry and financing are feasible. Approval, land and construction constraints may delay or prevent that response. The principle predicts an incentive, not an immediate guaranteed normalization of returns.
Why This Is the Correct Answer
Option B is correct because above-normal expected profits attract new entry and added supply when entry and financing are feasible. That added competition can put pressure on returns. Constraints on approvals, land or construction may delay or prevent the response, so the principle describes a tendency.
Why the Other Options Are Wrong
Option A: Permanent above-normal profits for the existing owners
Option A, permanent above-normal profits for the existing owners, contradicts the competition principle. High profits tend to attract competitors that can erode those returns.
Option C: A legal requirement that existing owners reduce rents
Option C, a legal requirement that existing owners reduce rents, is not part of the competition principle. The principle describes a market incentive, not a legal mandate.
Option D: No potential change in development activity
Option D, no potential change in development activity, ignores the incentive that high profits create. With feasible entry, those profits tend to encourage new development.
Profit Attracts Competition
Where profits are unusually high, competitors are drawn in, and their added supply tends to squeeze those profits.
How to use: Use this to reject answers claiming high profits will last permanently or cause no change in development.
Exam Tip
Choose the answer that describes a tendency toward new supply and pressure on returns rather than a guaranteed or legally required outcome.
Common Mistakes to Avoid
- -Assuming high profits will continue indefinitely
- -Believing the competition response is immediate in every market
- -Ignoring supply constraints that can delay new competition
Concept Deep Dive
Analysis
This question tests the principle of competition. When expected profits are unusually high and entry is feasible, new competitors are drawn in and added supply can put pressure on returns. The principle describes an incentive and tendency, not a certain or immediate outcome.
Background Knowledge
The principle of competition holds that excess profits tend to attract competition, which can increase supply and reduce returns toward typical levels. Supply responses can be slowed by approval processes, land availability, construction time and financing. Appraisers consider this when projecting income and supply in markets with unusually high returns.
Real-World Application
Rental houses in a growing town earn unusually high returns. Builders notice and propose several new rental subdivisions, so an appraiser valuing an existing rental house considers how the coming supply may affect future rents and occupancy.
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