Assertion (A): With free entry and exit, a leftward shift of the demand curve reduces the number of firms even though the price returns to its old level.
Reason (R): At a price below the minimum average cost, firms earn less than normal profit, so some of them exit and the price rises back to the minimum average cost.
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → Both (A) and (R) are true and (R) is the correct explanation of (A).
Assertion (A): With free entry and exit, a leftward shift of the demand curve reduces the number of firms even though the price returns to its old level. — True. After a leftward demand shift, firms leave until the price is back at min AC. Fewer firms now supply the smaller quantity, so the number of firms falls.
Reason (R): At a price below the minimum average cost, firms earn less than normal profit, so some of them exit and the price rises back to the minimum average cost. — True. Below min AC, firms earn less than normal profit, so some exit. Supply falls and the price rises back to min AC.
Why R explains A?
A leftward demand shift first pushes the price below min AC. R says what follows: losses make some firms leave, and the price climbs back. The firms that left are why the number of firms is smaller, even though the price is the same as before.
NCERT (2026-27): “5.1.2 Market Equilibrium: Free Entry and Exit … Recall from the previous chapter that the firms will earn supernormal profit so long as the price is greater than the minimum average cost and at prices less than minimum average cost, they will earn less than normal profit. Therefore, at prices greater than the minimum average cost, new firms will enter, and at prices below minimum average cost, existing firms will start exiting. …” “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.” |