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CA Foundation · Business Economics · Price Determination in Different Markets

A perfectly competitive industry is in long-run equilibrium with constant costs. Demand for the product then rises permanently. Which sequence correctly describes the adjustment?

Price initially rises and firms earn supernormal profits, which attract new entrants. Supply expands until price falls back to the original minimum average cost, since costs are constant. In the new long-run equilibrium the price is unchanged, firms earn normal profit, and industry output is larger.

  1. APrice rises and stays higher, since firms cannot enter the industry
  2. BPrice rises, firms earn supernormal profit, new firms enter, supply increases and price returns to the original long-run level with larger industry outputCorrect
  3. CPrice falls first, then firms exit until price returns to the original level with smaller industry output
  4. DPrice rises, existing firms permanently expand until their average cost rises to the new price

Explanation

Higher demand raises price above average cost, giving supernormal profit in the short run. Free entry increases supply until price returns to minimum average cost, which is unchanged in a constant-cost industry. Industry output ends higher through more firms. The option claiming a permanently higher price ignores free entry.

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