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 reduces the equilibrium quantity.
(B) A rightward shift of the demand curve raises the equilibrium price.
(C) A leftward shift of the demand curve reduces the number of firms.
(D) In equilibrium, each firm earns only normal profit.
(E) Compared with a fixed number of firms, a demand shift has a smaller effect on equilibrium quantity.
Choose the correct answer from the options given below:
Answer & explanation
Correct answer: option 3
The correct answer is Option (3) → (A), (C) and (D) only
With free entry and exit, the price always returns to minimum average cost. A demand shift changes only the quantity and the number of firms.
(A) A leftward shift of the demand curve reduces the equilibrium quantity. — Correct. Less is demanded at the same price, so less is supplied.
(B) A rightward shift of the demand curve raises the equilibrium price. — Incorrect. New firms enter and bring the price back to min AC, so the price stays the same.
(C) A leftward shift of the demand curve reduces the number of firms. — Correct. At the old price there is excess supply; the price tends to fall, losses follow and some firms leave.
(D) In equilibrium, each firm earns only normal profit. — Correct. Supernormal profit draws firms in and losses push them out, so only normal profit remains.
(E) Compared with a fixed number of firms, a demand shift has a smaller effect on equilibrium quantity. — Incorrect. With free entry and exit the whole shift goes into quantity, so the effect on quantity is larger, not smaller.
NCERT (2026-27): “5.1.2 Market Equilibrium: Free Entry and Exit … Thus, with free entry and exit, each firm will always earn normal profit at the prevailing market price. …” “Summary … With free entry and exit, the shift in demand has no impact on equilibrium price but changes the equilibrium quantity and number of firms in the same direction as the change in demand. In comparison to a market with fixed number of firms, the impact of a shift in demand curve on equilibrium quantity is more pronounced in a market with free entry and exit.” |