Arrange the given statements in chronological order stating the implications of free entry and exit assumptions in an equilibrium market.
(A) Supply curve shifts rightward, however demand remains unchanged.
(B) At the prevailing market price, each firm is earning a supernormal profit and will attract some new firms.
(C) Market prices fall, and supernormal profits are eventually wiped out.
(D) All firms in the market are earning normal profit, no more firms will have incentive to enter.
Choose the correct answer from the options given below:
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → (B), (A), (C), (D)
Free entry and exit means that firms can easily enter a market or leave it. So in equilibrium no firm earns supernormal profit, that is, profit above the normal level. The steps show why:
(B) At the prevailing market price, each firm is earning a supernormal profit and will attract some new firms. — This is the start. The extra profit draws new firms into the market.
(A) Supply curve shifts rightward, however demand remains unchanged. — More firms mean more market supply at each price, while buyers have not changed.
(C) Market prices fall, and supernormal profits are eventually wiped out. — With more supply and the same demand, the price falls, and profit falls with it.
(D) All firms in the market are earning normal profit, no more firms will have incentive to enter. — Normal profit is the minimum profit needed to stay in business. It gives outsiders no reason to come in, so entry stops.
NCERT (2026-27): “5.1.2 Market Equilibrium: Free Entry and Exit … 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.…” |