Question

Explain the implication of nature of entry (free or closed) for the profits earned by a firm in the long-run.

Answer 1

1. Free Entry and Exit: In market structures like perfect competition and monopolistic competition, there is freedom of entry and exit:
   • New firms can easily enter the industry if they see existing firms earning abnormal (supernormal) profits.
   • This increases market supply, leading to a decrease in the price of the product.
   • Eventually, the abnormal profits are eliminated, and all firms earn only normal profits in the long run.
   • Similarly, if firms incur losses, they can freely exit, reducing supply and stabilizing the market.
   • “The condition of free entry and free exit ensures that all the firms under perfect competition end up earning only normal profits in the long run.”
2. Closed or Restricted Entry (Monopoly): In a monopoly, entry is barred or highly restricted:
   • There is only one seller, and no new firm can enter to compete.
   • As a result, the monopolist can continue earning abnormal profits in the long run because no new supply is added to reduce the price, and the monopolist controls the entire supply and influences the price.