Read the following statements - Assertion (A) and Reasoning (R):
Assertion: Normal profit is earned by a firm at the prevailing market price.
Reasoning: There is free entry and exit of firms.
From the given alternatives choose the correct one:
Answer & explanation
Correct answer: option 2
Both Assertion (A) and Reasoning (R) are true and Reasoning (R) is the correct explanation of Assertion (A).
The correct answer is Option 2:
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Assertion (A): "Normal profit is earned by a firm at the prevailing market price."
- This is true because in a perfectly competitive market with free entry and exit, firms cannot earn supernormal profits in the long run.
- Due to competition, firms operate at the point where Price = Average Cost, ensuring that they earn only normal profit (zero economic profit).
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Reasoning (R): "There is free entry and exit of firms."
- This is true because in a perfectly competitive market, firms are free to enter when they see profit opportunities and exit when they incur losses.
- This mechanism ensures that in the long run, firms earn only normal profit.
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Does Reasoning (R) correctly explain Assertion (A)?
- Yes, because free entry and exit of firms eliminate supernormal profits and losses, leading to a market equilibrium where firms earn only normal profit.