Question

The market for produce is close to perfect competition. To most consumers one tomato is indistinguishable from another and who produced the tomato isn't a factor in decisions about whether to buy one or not. There are few barriers to entry, as anyone can plant tomatoes and try to sell them. There are no proprietary trade secrets for growing tomatoes. How does the free entry and exit of competitors affect prices in markets such as this?

a. Prices are unaffected by the entry and exit of producers, since prices are a function of the supply and demand curves, not the number of producers.

b. When producers are making an economic profit, competitors will produce more to make the same profit, but they will charge the same prices.

c. As producers start to make an economic profit, they will hold down prices in order to discourage competitors from entering the market and stabilizing prices at the equilibrium price.

d.

If producers are making an economic profit, competitors can easily enter the market, increasing supply and lowering prices.

Answer 1

Since the market is close to perfect competition and there are few barriers to entry, a new firm is free to enter the industry and an existing firm to leave it. Because of free entry and exit, firms in the long run make normal profits because in case there are extra normal profits, new firms will join the industry causing the market supply to increase and market price to fall because of which extra normal profits will be wiped out. In case of extra normal losses, some of the existing firm will leave the industry causing the market supply to decrease and market price to increase because of which extra normal losses will be wiped out. Because of free entry, new producers producing the same product join the market which increases the supply in the market. As the supply now exceeds the demand, the market price will fall as the producers will be selling any amount of the commodity at a lower price.

So, the answer is that if producers are making an economic profit, competitors can easily enter the market, increasing supply and lowering prices.