Decisions about entry and exit in a market of this type depend on the

Decisions about entry and exit in a market of this

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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 new firms. If firms  already in the market are profitable, then new firms will 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, then 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. Figure 6 Short-Run Market Supply In the short run, the number of firms in the market is fixed. As a result, the market supply curve, shown in panel (b), reflects  the individual firms' marginal-cost curves, shown in panel (a). Here, in a market of 1,000 firms, the quantity of output supplied  to the market is 1,000 times the quantity supplied by each firm.
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Recall that we can write a firm's profit as Profit = ( P − ATC) × Q . 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. This analysis has a surprising implication. We noted earlier in the chapter that  competitive firms maximize profits by choosing a quantity at which price equals  marginal cost. We just noted that free entry and exit force price to equal average total  cost. But if price is to equal both marginal cost and average total cost, these two  measures of cost must equal each other. Marginal cost and average total cost are  equal, however, only when the firm is operating at the minimum of average total cost.  Recall from the preceding chapter that the level of production with lowest average  total cost is called the firm's  efficient scale . Therefore,  in the long-run equilibrium of a  competitive market with free entry and exit, firms must be operating at their efficient   scale .
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