Which of the following will be true if the firm is in a perfectly competitive market and the price is P1 ?

Question

BlackTom AI · Accepted Answer

To begin, let's restate the question and all answer options to set the stage for analysis.
Question: Which of the following will be true if the firm is in a perfectly competitive market and the price is P1?
Options:
1) In the long run, existing firms in the industry will produce an output level greater than Q1.
2) The firm will earn short-run profits but suffer long-run losses.
3) In the long run, existing firms will leave the industry.
4) New firms will be dissuaded from entering the industry, at least until the price increases.
5) Firms will leave the industry until profits are increased.

Now, evaluate each option carefully:
Option 1: In the long run, existing firms in the industry will produce an output level greater than Q1. In perfect competition with free entry and exit, long-run equilibrium occurs where price equals the minimum of average total cost (P = ATC) and firms earn zero economic profit. The output level of existing firms is determined by market demand and the competitive firm’s profit-maximizing quantity, but there is no inherent reason that aggregate industry output must exceed the quantity Q1 just because P = P1. Therefore, this statement is not necessarily true; it overstates the implied long-run outcome.
Option 2: The firm will earn short-run profits but suffer long-run losses. In a perfectly competitive market, if firms earn profits in the short run, new entrants will attract, shifting supply to drive profits to zero in the long run. Thus the claim that profits exist in the short run but become losses in the long run is inconsistent with long-run equilibrium behavior in perfect competition, where profits are driven to zero, not negative, under entry/exit dynamics. This option misstates the typical long-run outcome.
Option 3: In the long run, existing firms will leave the industry. This aligns with the standard result when the price P1 is at a level where the short-run equilibrium yields economic losses for existing firms, or when P1 is below the minimum average total cost, prompting exits until price rises or until profits reach zero. If the diagram indicates P1 is at a level that cannot sustain all existing firms profitably in the long run, exits occur. So this statement can be true depending on cost conditions, and given the context it is plausible.
Option 4: New firms will be dissuaded from entering the industry, at least until the price increases. In perfect competition, if profits are zero in the long run, there is no incentive for new entrants, but the phrasing 
‘dissuaded from entering, at least until the price increases’ suggests a barrier to entry until a higher price arises. In a standard model with free entry, new firms would enter if profits were positive and would not wait for a higher price when profits are positive; conversely, if profits are zero, entrants do not enter. The statement is misleading because it implies entry would be deterred while prices could rise, which contradicts the mechanism where positive profits attract entry and zero profits deter entry.
Option 5: Firms will leave the industry until profits are increased. This statement asserts that exits occur specifically to raise profits, which aligns with the general intuition that if profits are negative in the long run, firms exit to push profits toward zero by reducing supply. However, in a standard long-run competitive equilibrium, exits occur until profits are zero, not necessarily “increased” profits, since the new equilibrium price times quantity yields zero economic profit. The wording is somewhat awkward, but the core idea that exits occur to restore profitability aligns with the mechanism, though the emphasis on profits being increased is not precise.

Taken together, the option that best matches the long-run adjustment process in a perfectly competitive market with price P1—where exit occurs to eliminate losses and move toward zero economic profit—is option 3: In the long run, existing firms will leave the industry. The other options either state outcomes that contradict the zero-profit long-run equilibrium, rely on misinterpretations of entry/exit dynamics, or contain imprecise wording about profits and price adjustments. The key insight is that long-run equilibrium in perfect competition features no economic profit and potential exits if firms incur losses; hence, exits are the mechanism by which the industry moves toward that equilibrium.

AP Economics-Hillebrand AP Microeconomics Sem 1 Exam 2025 - Requires Respondus LockDown Browser

Which of the following will be true if the firm is in a perfectly competitive market and the price is P1 ?

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