Question 8: How is the equilibrium number of firms determined in a market where entry and exit is permitted?
Answer:
The characteristic of free entry and exit of firms ensures that all the firms in a perfect competitive market earn normal profit, i.e. the market price is always equal to the minimum of LAC. No new firm will be attracted to enter the market or no existing firm will leave, if the price is equal to the minimum of LAC. Thus, the number of firms is determined by the equality of price and the minimum of LAC. The market equilibrium is determined by the intersection of market
demand curve (D1D1) and the price line. The equilibrium price is P1 and the equilibrium output is q1. At this equilibrium price, each firm supplies the same output q1f. as it is assumed that all the firms are identical. Therefore, at the equilibrium, the number of firms in the market is equal to the number of firms required to supply output q1 at price P1, and each in turn supplying q1f amount at the price. That is n =
Where,
n = number of firms at market equilibrium
q1 = the equilibrium quantity demanded
q1f = the quantity of output supplied by each firm
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