Describe the entry/exit condition in a perfectly competitive market. Further, detail why this condition hinges on...

Describe the entry/exit condition in a perfectly competitive market. Further, detail why this condition hinges on the relative position of MC and ATC. Why is AVC not important for the entry/exit condition? Can you tell what happens to revenues for a given firm in this market as more firms enter?

Solutions

Expert Solution

(a) In a perfectly competitive market, entry and exit are free. If firms make short run economic profit, new firms will enter and if firms are incurring short run economic loss, firms will exit the market.

(b) A perfectly competitive firm maximizes profit (or minimizes loss) by equating price with Marginal cost (MC). Since profir per unit is equal to Price less ATC, it means unit profit equals MC less ATC. If MC lies above ATC, firm makes profit and new firms will enter. If MC lies below ATC, the firm is making loss and some firms will exit.

(c) AVC is not important since short run profit or loss is determined by the difference between MC and ATC curves, not be difference between MC and AVC curves.

(d) As more firms enter, market supply rises which lowers market price. At the same time, individual firm's demand falls since there are higher number of firms in market. So firm revenue decreases with new entry.

Rahul Sunny answered 1 year ago

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