The correct answer is B. earn average returns. Competitive parity refers to a situation in which a firm has achieved a level of performance that is on par with its competitors. In this explanation, we’ll detail why this answer is correct and why the other options are not suitable for describing the outcomes of firms that have achieved competitive parity.

B. Earn Average Returns (Correct Answer):

When a firm has achieved competitive parity, it means that it has successfully matched the performance, capabilities, and strategies of its competitors. This implies that the firm is operating at a level that is consistent with the industry norms and standards. As a result, the firm can typically expect to earn average returns in such a competitive environment.

Here’s a more detailed explanation:

1. Market Equilibrium:

Competitive parity signifies that the firm is neither outperforming nor underperforming its competitors. It has reached a state of equilibrium where its products, services, pricing, and overall market positioning are in line with what the competition offers. This generally results in the firm earning returns that are in line with the industry average.

2. Normal Profit:

In a competitive market, firms strive to earn a return that is at least equal to their cost of capital. This ensures they cover their operating costs and generate a profit. Firms that have achieved competitive parity are effectively operating at the level of their peers, and their profits are likely to be consistent with the industry average, resulting in what is often considered an “average” return.

3. No Sustainable Competitive Advantage:

Competitive parity implies that the firm does not have a significant sustainable competitive advantage over its rivals. If it did, it would be able to outperform the competition and earn above-average returns. Instead, competitive parity suggests that the firm’s advantages are comparable to those of its competitors.

Now, let’s discuss why the other options are not correct:

A. Earn Below-Average Returns:

Earning below-average returns would typically suggest that a firm is underperforming in a competitive market. Achieving competitive parity, however, means that the firm is at par with its competitors, indicating that it is not underperforming. While a firm might earn below-average returns in certain situations, this would not be the expected outcome of competitive parity.

C. Earn Above-Average Returns:

Earning above-average returns is typically associated with firms that have a sustainable competitive advantage, allowing them to outperform their rivals. Competitive parity, by definition, implies that the firm is not outperforming its competitors but rather matching their performance. Therefore, earning above-average returns would not align with the concept of competitive parity.

D. Initially Earn Above-Average Returns, Declining to Average Returns:

This option implies that a firm may initially perform exceptionally well but then experiences a decline in performance over time. While this might occur for some firms, it is not a necessary or expected outcome of competitive parity.

Competitive parity indicates a situation where the firm’s performance is consistent with the competition, and it does not suggest an initial phase of above-average returns followed by a decline.

In summary, when a firm achieves competitive parity, it means that it is operating at a level consistent with its competitors, without a significant advantage or disadvantage. Therefore, the most appropriate expectation for such a firm is to earn average returns, as its performance aligns with industry standards and market equilibrium.

The other options do not accurately represent the expected outcomes of firms that have achieved competitive parity and are not consistent with the core concept of competitive equilibrium in a competitive market.