Consider the following statements about a perfectly competitive market of identical firms with free entry and exit:
(A) A leftward shift of the demand curve lowers the equilibrium price.
(B) A rightward shift of the demand curve raises the number of firms.
(C) If firms earn less than normal profit, some firms exit and the market price rises.
(D) New firms keep entering even after the price has fallen to the minimum average cost.
(E) The equilibrium number of firms equals the market quantity divided by the output of each firm at that price.
Choose the correct answer from the options given below:
Answer & explanation
Correct answer: option 4
The correct answer is Option (4) → (B), (C) and (E) only
With free entry and exit, firms enter when there is supernormal profit and leave when there is a loss. So the price always returns to minimum average cost, and the number of firms adjusts instead.
(A) A leftward shift of the demand curve lowers the equilibrium price. — Incorrect. Firms leave until the price is back at minimum average cost, so the price stays the same; only quantity and the number of firms fall.
(B) A rightward shift of the demand curve raises the number of firms. — Correct. Higher demand first lifts the price, supernormal profit draws new firms in, and the price comes back down.
(C) If firms earn less than normal profit, some firms exit and the market price rises. — Correct. With losses, some firms exit. Supply falls and the price rises till profit is back to normal.
(D) New firms keep entering even after the price has fallen to the minimum average cost. — Incorrect. At minimum average cost every firm earns only normal profit, so no new firm wants to enter.
(E) The equilibrium number of firms equals the market quantity divided by the output of each firm at that price. — Correct. Each firm supplies the same amount at p0, so the number of firms is n0 = q0 / q0f.
NCERT (2026-27): “5.1.2 Market Equilibrium: Free Entry and Exit … 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.” “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.” “5.1.2 Market Equilibrium: Free Entry and Exit … At p0 = min AC each firm supplies same amount of output,”
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