THE LONG RUN: MARKET SUPPLY WITH ENTRY AND EXIT
Decisions about entry and exit in a market of this type depend on the incentives facing the owners of existing firms and the entrepreneurs who could start firms. If firms already in the market are profitable, then new firms have an incentive to enter the market; This entry will expand the number of firms, increase the quantity of the good supplied, and drive down prices and profits. Conversely, if firms in the market are making losses, some existing firms will exit the market. Their exit will reduce the number of firms, decrease the quantity of the good supplied, and drive up prices and profits. At the end of this process of entry and exit. firms that remain in the market must be making zero economic profit.
This equation shows that an operating firm has zero profit if and only if the price of the good equals the average total cost of producing that good. If price is above average total cost, profit is positive, which encourages new firms to enter. If price is less than average total cost, profit is negative, which encourages some firms to exit. The process of entry and exit ends only when price and average total cost are driven to equality.
From this analysis of firm behavior, we can determine the long-run supply curve for the market. In a market with free entry and exit, there is only one price consistent with zero profit-the minimum of average total cost. As a result, the long-run market supply curve must be horizontal at this price, as
illustrated by the perfectly elastic supply curve .in panel (b) of Figure 7. Any price above this level would generate profit. leading to entry and an increase in the total quantity supplied. Any price below this level would generate losses, reading to exit and a decrease in the total quantity supplied. Eventually, the number of firms the market adjusts so that price equals the minimum of average total cost,there are enough firms to falsify all the demand t this price.
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