Suppose the price at which equilibrium is attained in exercise 5 is above the minimum average cost of the firms constituting the market. Now if we allow for free entry and exit of firms, how will the market price adjust to it?
In the above question the equilibrium price is Rs 9, where market demand is equal to market supply at 60 units.
If this equilibrium price of Rs 9 is above the minimum of average cost then it means the firm is earning supernormal profit, this situation will attract new firms in the market and with the new entrants the supply will increase.
The increase in supply will result in fall in price until it becomes equal to the minimum of average cost and so the supernormal profit will be wiped out and all the firms will earn normal profit.
When free entry and exit of firms is allowed equilibrium is determined by the intersection of demand curve and P is equal to minimum average cost line.
