Two markets for the same good face the same leftward shift of the demand curve. Market X has a fixed number of firms. Market Y has identical firms that can enter and exit freely. Which of the following is correct for Market Y, compared with Market X?
Answer & explanation
Correct answer: option 3
The correct answer is Option (3) → The price stays the same, the quantity falls by more and some firms exit
In Market Y, the fall in demand first pushes the price below minimum average cost. Firms make losses, some firms exit, and the price comes back to minimum average cost.
So in Y the price ends where it began. The whole fall in demand shows up in quantity, so the quantity falls by more than in Market X.
With a fixed number of firms, a demand shift changes both price and quantity; with free entry and exit, only the quantity and the number of firms change.
NCERT (2026-27): “Shifts in Demand … Similarly, for a leftward shift of the demand curve to DD2, there will be excess supply at the price p0. In response to this excess supply, some firms, which will be unable to sell their desired quantity at p0, will wish to lower their price. The price tends to decrease which will lead to the exit of some of the existing firms and the price will again reach p0. Therefore, in the new equilibrium, less quantity will be supplied which will be equal to the reduced demand at that price. This is shown in panel (b) where due to the shift of demand curve from DD0 to DD2, quantity demanded and supplied will decrease to q2 whereas the price will remain unchanged at p0. Here, the equilibrium number of firms, n2 is less than n0 due to the exit of some existing firms.” “Shifts in Demand … Thus, due to a shift in demand rightwards (leftwards), the equilibrium quantity and number of firms will increase (decrease) whereas the equilibrium price will remain unchanged. Here, we should note that with free entry and exit, shift in demand has a larger effect on quantity than it does with the fixed number of firms. But unlike with fixed number of firms, here, we do not have any effect on equilibrium price at all.” |