The following figure represents the cost curves and the market price for a perfectly competitive firm. Which of the following statements is true about the long run equilibrium in this market?

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BlackTom AI · Accepted Answer

To tackle this question, we start by recalling what long-run equilibrium in a perfectly competitive market looks like: in the long run, price equals the minimum average total cost (P = min ATC). If the market price is above min ATC, firms earn positive profits and new firms enter; if it is below min ATC, firms incur losses and exit. This entry/exit process continues until P = min ATC.

Option A: 'More firms enter, price falls, and each firm produces more quantity.' This would occur if the current price were above the break-even level and profits were positive, which would attract entry. However, in long-run equilibrium, price should settle at min ATC; the question’s figure indicates the market is in a state where adjustments via exit are relevant rather than ongoing entry. Moreover, the standard long-run outcome after adjustment is not necessarily 'more firms enter' once equilibrium is reached.

Option B: 'More firms enter, price falls, and each firm produces less quantity.' Here, entry would push price down, reducing profits, but this description also misstates the typical per-firm response: when price falls due to entry, firms do not produce less quantity due to a fall in price; they would produce less only if price fell below marginal cost, which would not be consistent with a clean long-run adjustment to P = min ATC across all firms.

Option C: 'Some firms exit, price increases, and each firm produces more quantity.' This aligns with the mechanism of exit reducing market supply, which raises the market price. With a higher price, each remaining firm produces more (as marginal cost equals the new higher price at a higher quantity). This is a consistent description of long-run adjustment toward P = min ATC where fewer firms operate but each operates at a higher output given the higher price.

Option D: 'Some firms exit, price increases, and each firm produces less quantity.' While exit can raise price, a higher price generally induces firms to increase production, not reduce it, since firms maximize profit by producing where MC = P. A decrease in per-firm output would imply a misalignment with the profit-maximizing condition MC = P at the higher price.

In sum, the only option that correctly describes the standard long-run adjustment path in perfect competition—exit of some firms, a higher market price, and higher output per remaining firm—is Option C.

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The following figure represents the cost curves and the market price for a perfectly competitive firm. Which of the following statements is true about the long run equilibrium in this market?

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