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:

Both Assertion (A) and Reasoning (R) are true and Reasoning (R) is the correct explanation of Assertion (A).

Both Assertion (A) and Reasoning (R) are true and Reasoning (R) is the correct explanation of Assertion (A).

The correct answer is Option 2:

• 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).

• 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.

• 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.