Question

1. Describe in detail the process that causes entry in the long-run pure competition framework?

2. Describe in detail the process that causes exit in the long-run pure competition framework?

Answer 1

1. A pure competition is defined as the market where there are large number of buyers and sellers such that each buyer and seller has no influence on market price. There are no barriers to entry of new firms in the market and firms sell homogenous product so that price is the only consideration in the eyes of buyers. And the firms in pure competition in the long run earns normal profit or in term of economics, zero economic profit.

Now in the long run of there is price cost margin is positive such that firms are earning supernormal profits, this creats an incentive for firms outside the market to join the market in order to earn some profit. But as we discussed earlier the good sold by firm being homogenous and there are large number of sellers and buyers, so new firms entering the market tries to lower its price in order to attract consumers, as a result all the firms reduces their prices to compete with the new firm for market share and these new and entry of firms and more competition Continues until the price becomes equal to the marginal cost of production. Such that each firm under pure competition earns zero economic profit or in other words normal profits.

2. As discussed in part 1 how new firms enters the market and extranormal profits disappears as a result of severe competition among competing firms.

Now we discussed that new firms enters the market when there are positive economic profits to be earned but sometimes when there are positive economic profits in the market new firms enters and cuts its price in order to capture consumers base. And this entering of new firms and cutting of prices sometimes becomes very severe and due to this intense competition the price becomes lower than marginal cost of production. Which means firms starts to make negative economic profits which are losses. So as soon as firms realise this, they starts to exit the market and the slowly the competition becomes less intense and price starts to increase. The exit of firms and increase in prices continues to happen until price becomes equal to the marginal cost of production.

So in pure competition the entry and exit of new firms continues to take place until the long run equilibrium in pure market is achieved where ghe marginal cost of production is equal to the market price. When there are incentive for new firms to enter market or the existing firms to exit the market.

I hope I was able to help you, thank you.