In a perfectly competitive market of identical firms with free entry and exit, the price of an input rises, so that the minimum average cost of every firm rises. The demand curve does not change. In the new equilibrium:
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → the price rises to the new minimum average cost and the equilibrium quantity falls
With free entry and exit, the price always settles at the firms’ minimum average cost. If that cost rises, firms that now make losses leave until the price reaches the new, higher minimum average cost.
The quantity is set by the demand curve at that price. The demand curve slopes down and has not moved, so at the higher price buyers want less. The equilibrium quantity falls.
NCERT (2026-27): “5.1.2 Market Equilibrium: Free Entry and Exit … From the above, it follows that the equilibrium price will be equal to the minimum average cost of the firms. In equilibrium, the quantity supplied will be determined by the market demand at that price so that they are equal. Graphically, this is shown in Figure 5.5 where the market will be in equilibrium at point E at which the demand curve DD intersects the p0 = min AC line such that the market price is p0 and the total quantity demanded and supplied is equal to q0.” |