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CA Foundation · Business Economics · Price Determination in Different Markets

In the long run, if firms in a perfectly competitive industry are earning supernormal profits, which sequence of events is expected?

New firms enter the industry, market supply increases, and the price falls until only normal profit remains. Free entry in perfect competition means supernormal profits attract entrants. The process stops when price equals minimum long-run average cost and there is no further incentive to enter.

  1. AExisting firms exit, supply falls, price rises until profits vanish
  2. BNew firms enter, supply increases, price falls until only normal profit remainsCorrect
  3. CFirms collude to restrict output and keep profits high
  4. DDemand falls automatically, lowering price to average variable cost

Explanation

Free entry and exit are features of perfect competition. Supernormal profits attract new firms, shifting market supply rightward and lowering the price. Entry continues until price equals minimum average cost and only normal profit remains. Exit with rising price describes the response to losses.

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