Question

Explain the implications of the following in a perfectly competitive market:

Freedom of entry and exit to firms

Explain the implications of Given

Freedom of entry and exit of firms under perfect competition

Answer 1

Freedom of entry and exit to firms:-

New firms are free to enter and existing firms are free to exit in a perfectly competitive market. This situation is possible only in the long period because new firms will join the industry with the attraction of extra-normal profit. There will be an increase in the market supply, and hence, the price will decrease. Thereby the extra normal profit will decrease. Further, if the industry incurs extra normal loss, some existing firms will tend to leave the industry which will lead to a decline in market supply and market price. The industry will not incur extra normal loss. This is how the firms in the long run earn neither extra profit nor extra loss in the industry. Thus, firms were able to earn normal profit which prevents a firm from exiting or a new firm from entering the industry.