Explain the implication of ‘freedom of entry and exit to the firms’ under perfect competition.
The basic implication of the feature of freedom of freedom of entry and exit of the firms under perfect competition is that all firms in the market earn zero economic profit in the long run. Each individual firm is able to operate at the point where the minimum of long run average cost curve (LAC) is tangent to the price line. This implies that the firm neither earns super normal profits nor suffers abnormal losses.
If, the firms are earning super normal profits (that is, the price is greater than the minimum of LAC) then, it attracts new firms in the market. Consequently, the total output in the industry increases and the price falls. Price continues to fall till it becomes equal to the minimum of the LAC curve and the super-normal profits are wiped out.
As against this, if the firms are suffering abnormal losses (that is, the price is less than the minimum of LAC) then, it leads some of the firms to exit the market. Consequently, the total output in the industry falls and the price rises. Price continues to rise till it becomes equal to the minimum of the LAC curve and the abnormal losses are wiped out.
Thus, freedom of entry and exit of firms under perfect competition implies that all firms earn only normal profits in the long run.