Which of the following statements is correct regarding the equilibrium in a perfectly competitive market with free entry and exit?

Correct Option

The correct option is A shift in demand changes the number of firms in the market.

Explanation

In a perfectly competitive market, the feature of free entr is the decisive factor for long-run equilibrium. This mechanism ensures that firms earn only normal profits (zero economic profit) in the long run, and the market price settles at the minimum point of the Average Total Cost (ATC) curve.

Detailed Analysis:

• A shift in demand changes the equilibrium price permanently. is Incorrect: In a standard perfectly competitive model (specifically a constant-cost industry), a shift in demand affects the price only in the short run. In the long run, the entry or exit of firms adjusts the supply until the price returns to the original level (minimum ATC). Thus, the price does not change permanently.
• A shift in demand changes the number of firms in the market. is Correct: A shift in demand triggers an adjustment in the market structure:
  • If demand increases, the short-run price rises, leading to supernormal profits. This attracts new firms to enter the market, increasing supply until profits normalize.
  • If demand decreases, the short-run price falls, causing losses. This leads to the exit of existing firms, decreasing supply until losses are eliminated.
  Therefore, the primary long-run effect of a demand shift is a change in the number of firms and total output.
• Firms can earn supernormal profits in the long run. is Incorrect: Firms can earn supernormal profits only in the short run. In the long run, the entry of new competitors increases market supply, driving the price down until all firms earn only normal profit.
• The supply curve is perfectly inelastic. is Incorrect: The long-run supply curve in a perfectly competitive, constant-cost industry is perfectly elastic (horizontal). This indicates that the market will supply any quantity at the price equal to the minimum average cost. It is not perfectly inelastic (vertical).

Key Takeaway:
In perfect competition with free entry and exit, shifts in demand are accommodated in the long run by a change in the number of firms (market capacity) rather than a permanent change in the equilibrium price.