Which of the following is an example of The Big Squeeze? Select one:
a. High profits drive out businesses, which increases supply, and drives down prices.
b. High profits aftract new entrants, which increases supply, and drives up prices.
c. High profits attract new entrants, which increases supply, and drives down prices.
d. High profits drive out businesses, which increases supply, and drives up prices.
The correct answer and explanation is:
The correct answer is c. High profits attract new entrants, which increases supply, and drives down prices.
Explanation:
The “Big Squeeze” refers to a phenomenon in markets where high profits in an industry or market segment attract new competitors, which increases the overall supply of the product or service. As a result, the increased supply leads to a decrease in prices, often squeezing the profitability of the initial businesses. This is a common feature in competitive market structures, especially in perfect or monopolistic competition, where firms have easy entry and exit conditions.
Breakdown of the concept:
- High Profits Attract New Entrants: When a business or industry shows high profits, it signals to potential entrepreneurs that there are opportunities to earn in this market. This attracts new businesses to enter the market to capitalize on the profitable opportunity.
- Increase in Supply: As new competitors enter the market, they increase the supply of the good or service being offered. More products or services are available for consumers, which generally leads to an oversupply in comparison to demand.
- Prices Fall: As supply increases, competition among businesses intensifies. To attract consumers, firms may lower their prices, driving down the overall price levels in the market. This is a direct result of the increased competition and higher supply relative to demand.
- Decreased Profitability: As prices drop, the once-high profits of the initial businesses are squeezed. The price reduction can lead to a situation where the market no longer offers the same level of profitability as it did initially. This process is known as the “Big Squeeze” because the pressure from increased supply forces prices to fall and reduces the ability of businesses to maintain their previous profit margins.
This cycle can continue until the market reaches a point where the supply stabilizes, or until businesses exit the market because the profit potential has been diminished.