The principle of competition predicts that unusually high profits in a market segment will:
Correct Answer
B) Attract new supply until returns normalize
Why this is correct: The principle of competition states that excess profits (above-normal returns) in a market will attract new competitors (developers/investors), increasing supply until the added competition drives profits back down to a normal level. This self-correcting mechanism is fundamental to market analysis. Why the other choices are wrong: 'Persist indefinitely for early entrants' is the opposite of what competition predicts. 'Cause existing owners to reduce rents' might be a result of new supply, but it's not the direct prediction of the principle. 'Have no effect on future development' ignores the core incentive that high profits create. Exam tip: High profits are a signal that says 'Build here!' New supply follows until profits are normal.
Why This Is the Correct Answer
Why this is correct: The principle of competition states that excess profits (above-normal returns) in a market will attract new competitors (developers/investors), increasing supply until the added competition drives profits back down to a normal level. This self-correcting mechanism is fundamental to market analysis. Why the other choices are wrong: 'Persist indefinitely for early entrants' is the opposite of what competition predicts. 'Cause existing owners to reduce rents' might be a result of new supply, but it's not the direct prediction of the principle. 'Have no effect on future development' ignores the core incentive that high profits create. Exam tip: High profits are a signal that says 'Build here!' New supply follows until profits are normal.
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