Free entry and exit

With free entry and exit, the number of firms can change.

• If firms earn supernormal profit, new firms enter, supply rises, and the price falls.
• If they make losses, firms exit, supply falls, and the price rises.

This goes on until each firm earns only normal profit. So the equilibrium price equals the minimum average cost: p = min AC.

Then:

• the quantity is read from the demand curve at that price;
• the number of firms = market quantity ÷ the output of each firm.

Example: demand is qD = 500 − p, and the minimum average cost is ₹20, at which each firm produces 40 units. Price = ₹20; quantity = 500 − 20 = 480; number of firms = 480 ÷ 40 = 12.

If demand now shifts, the price does not change (it stays at minimum AC); only the quantity and the number of firms change. And quantity changes more than it would with a fixed number of firms, since none of the shift is absorbed by a price change.