Figure 7-7 shows a firm in a perfectly competitive market. Which of the following is most likely to happen in the given market?Figure 7-7

Question

Quizplus · Accepted Answer

In a perfectly competitive market, firms are price takers and there are no barriers to entry or exit. Therefore, if profits are positive, new firms would be likely to enter the market, increasing supply and decreasing the market price. If profits are negative, existing firms would be likely to exit the market, decreasing supply and increasing the market price. In the given diagram, the price is shown as P1, which is below the average total cost of the firm. This indicates that the firm is making a loss in the short run. As a result, existing firms are likely to exit the market, decreasing supply and increasing the market price (from P1 to P2). However, in the long run, new firms are likely to enter the market, increasing supply and decreasing the market price again. Therefore, the most likely outcome in this market is that new firms would be likely to enter, decreasing the market price.

Figure 7-7 Shows a Firm in a Perfectly Competitive Market