Before 1991, every entrepreneur needed permission from government officials to start a firm. Which reform removed this barrier to entry, and what does the theory of market equilibrium with free entry and exit predict for an industry whose firms were earning supernormal profit?
Answer & explanation
Correct answer: option 4
The correct answer is Option (4) → Abolition of industrial licensing; new firms enter and supernormal profits are wiped out, leaving only normal profit
The need for government permission to start a firm was industrial licensing, and the 1991 reforms abolished it for almost all products. With free entry, supernormal profit draws new firms in, market supply rises and price falls until each firm earns only normal profit.
Dismantling quantitative restrictions opened the market to imports. It did not remove the permission needed to start a firm.
This question uses Liberalisation, Privatisation and Globalisation: An Appraisal and Market Equilibrium together.
NCERT (2026-27): “Deregulation of Industrial Sector: In India, regulatory mechanisms were enforced in various ways (i) industrial licensing under which every entrepreneur had to get permission from government officials to start a firm, close a firm or decide the amount of goods that could be produced (ii) private sector was not allowed in many industries (iii) some goods could be produced only in small-scale industries, and (iv) controls on price fixation and distribution of selected industrial products. The reform policies introduced in and after 1991 removed many of these restrictions. Industrial licensing was abolished for almost all but product categories — alcohol, cigarettes, hazardous chemicals, industrial explosives, electronics, aerospace and drugs and pharmaceuticals. …” Market Equilibrium, 5.1.2 Market Equilibrium: Free Entry and Exit: “In the last section, the market equilibrium was studied under the assumption that there is a fixed number of firms. In this section, we will study market equilibrium when firms can enter and exit the market freely. Here, for simplicity, we assume that all the firms in the market are identical. … This assumption implies that in equilibrium no firm earns supernormal profit or incurs loss by remaining in production; in other words, the equilibrium price will be equal to the minimum average cost of the firms. To see why it is so, suppose, at the prevailing market price, each firm is earning supernormal profit. The possibility of earning supernormal profit will attract some new firms. As new firms enter the market supply curve shifts rightward. However, demand remains unchanged. This causes market price to fall. As prices fall, supernormal profits are eventually wiped out. At this point, with all firms in the market earning normal profit, no more firms will have incentive to enter. Similarly, if the firms are earning less than normal profit at the prevailing price, some firms will exit which will lead to an increase in price, and with sufficient number of firms, the profits of each firm will increase to the level of normal profit. At this point, no more firm will want to leave since they will be earning normal profit here. Thus, with free entry and exit, each firm will always earn normal profit at the prevailing market price. …” |