Question

Describe how, in the long-run, a permanent decrease in demand can lead to exit of incumbent firms.

Answer 1

Profits are the main determinant which shows the existence of a firm in the market. Producers invest their money, time, effort to produce and sell something and hope for the returns through this. Not all firms can perfectly do these activities. This will leads to the leaving of the firm from the industry. Most of the perfectly competitive firms, there is a free entry and exit of the firms. If a firm’s product having low demand in the market will definitely get back from the market.
In long run the firms attain equilibrium at the lower point of the average cost curve. This point will be tangent to the demand curve. There is normal profit was attained by the firms in long run. If there is increase in the existing profit, new firms will be attracted to the industry. This new entrants may leads to the fall in price, and also increase the cost of production. This may lead to an upward shift of the cost curve. This will continue till the average cost curve’s tangency towards the demand curve which determines the market price. If the firm’s in the market create loss, they will leave the industry. The price will raises and the cost may fall as the industry contract until the remaining firms in the industry cover the total cost inclusive of the normal profit rate.