Question

How is the equilibrium number of firms determined in a market where entry and exist is permitted?

Answer 1

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 q_1f , 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 q_1f amount at this price. That is

`n=q_1/q_{1f}`

Where,

n = number of firms at market equilibrium

q₁ = the equilibrium quantity demanded

q_1f = the quantity of output supplied by each firm