In a market with free entry and exit of identical firms, the supply curve of each firm is qf = 2p – 30 for p ≥ 25 and qf = 0 for p < 25. Consider the following statements:
(A) Rs 25 is the minimum average cost of each firm.
(B) At a price below Rs 25, a firm would incur a loss and would exit the market.
(C) At a price of Rs 25, each firm supplies 20 units.
(D) At a price of Rs 25, each firm earns supernormal profit.
Choose the correct answer from the options given below:
Answer & explanation
Correct answer: option 3
The correct answer is Option (3) → (A), (B) and (C) only
A firm with free entry and exit never produces below its minimum average cost. So the price where its supply starts, Rs 25, is its minimum average cost.
(A) Rs 25 is the minimum average cost of each firm. — Correct. The firm supplies nothing below Rs 25, so Rs 25 is its minimum average cost.
(B) At a price below Rs 25, a firm would incur a loss and would exit the market. — Correct. Below minimum average cost, the firm makes a loss, so it leaves the market.
(C) At a price of Rs 25, each firm supplies 20 units. — Correct. qf = 2(25) − 30 = 50 − 30 = 20 units.
(D) At a price of Rs 25, each firm earns supernormal profit. — Incorrect. At a price equal to minimum average cost, each firm earns only normal profit. Supernormal profit needs a price above minimum average cost.
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. At the price level equal to the minimum average cost of the firms, each firm will earn normal profit so that no new firm will be attracted to enter the market. Also the existing firms will not leave the market since they are not incurring any loss by producing at this point. So, this price will prevail in the market.” |
