Entry, exit and competitive adjustment

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1. What you will learn

Analyze entry, exit and competitive adjustment using explicit assumptions, calculated results and a stated limit of the model.

2. Starting point

A price-taking firm compares marginal revenue with marginal cost and checks whether operating covers avoidable variable cost. Economic profit subtracts all opportunity costs. Long-run decisions can change commitments that were fixed in the short run.

3. Terms and units

4. Profit sends an entry signal

A competitive market can have a short-run equilibrium while its firms earn positive economic profit. Price clears the market for the existing set of suppliers, and each firm chooses its best current output. Positive profit then means revenue exceeds all the modeled opportunity costs, including the normal return to the owner's resources. If outsiders can enter on comparable terms, that excess return creates an incentive to do so. Short-run market clearing and long-run stability are different conditions.

Entry increases the number of firms offering output. Holding demand and other supply determinants fixed, the market supply curve shifts outward. The market price falls as the new supply meets demand. Each price-taking incumbent now faces a lower horizontal price line and adjusts its own output along the relevant cost relationship. The market can produce more overall even while each incumbent produces less. Distinguishing industry quantity from output per firm prevents an apparent contradiction.

This adjustment is a model mechanism, not an instantaneous event guaranteed in every real industry. Firms must obtain information, resources and permission to operate. Barriers to entry, strategic behavior, scarce licenses or proprietary technology can prevent the assumed response. Perfect competition treats such obstacles as absent or sufficiently limited for the long-run entry mechanism to operate. A conclusion about zero economic profit depends on those conditions.

Negative economic profit creates an exit incentive when firms can avoid the relevant costs by leaving. As firms exit, market supply shifts inward, tending to raise price for the remaining sellers. The process can continue until the remaining firms cover their opportunity costs. A firm may operate temporarily while losing money because it covers variable cost, yet exit later when a lease expires. Shutdown and exit differ because the sets of avoidable costs differ.

Term	What it means
Entry	A new firm begins supplying the market.
Exit	A firm leaves the industry and avoids costs that can be eliminated in the long run.
Normal return	Compensation for the opportunity cost of resources, already included in economic cost.
Long-run competitive equilibrium	A model outcome with no incentive for entry or exit and firms choosing their best feasible inputs and outputs.
Constant-cost industry	An industry whose expansion leaves the relevant firms' input prices and long-run cost conditions unchanged.
Increasing-cost industry	An industry whose expansion raises the relevant long-run cost conditions, for example through higher input prices.

Another way: Zero economic profit is not zero earnings

Suppose a firm sells ten units at fifteen dollars. Average variable cost is seven dollars and fixed economic cost is forty, so average fixed cost is four and average total cost is eleven. Economic profit is (15 - 11) times 10, or forty dollars. If the model's minimum long-run average cost is eleven and entry leaves those cost conditions unchanged, the fifteen-dollar price attracts entry. The long-run competitive price is eleven under the stipulated conditions.

At that price, a firm operating at its efficient scale earns zero economic profit. Revenue still pays workers, materials and the opportunity cost of the owner's resources. If the owner's alternative wage or capital return is included in economic cost, it is being covered. Calling zero economic profit 'earning nothing' would omit those compensated opportunities. Accounting profit can remain positive because the accounting convention may not deduct every implicit opportunity cost.

Zero economic profit is also not a claim that every firm has the same cash receipts or that owners experience no uncertainty. It is a condition in a model with specified costs and expected alternatives. If firms differ in productivity or own scarce resources, the distribution of returns can be more complicated. A scarce superior location may generate economic rent even when entry is otherwise possible. The identical-firm benchmark deliberately removes that complication so the adjustment can be isolated.

The equality P = ATC at a particular observed output does not by itself establish a full long-run competitive equilibrium. The firm must also be choosing output appropriately, using an optimal input combination, and facing no incentive for entry or exit under the industry's assumptions. In the conventional smooth model with identical firms and free entry, price equals marginal cost and minimum average total cost at the long-run operating point. These conditions work together; one isolated equality is not enough.

Another way: Separate a demand shock into two stages

Begin with a long-run competitive equilibrium in a constant-cost industry. Demand rises while the number of firms is initially fixed. In the short run, the market price rises, existing firms expand output and may earn positive economic profit. This is movement along the current short-run market supply curve, not the complete long-run response. The higher price signals an incentive for additional suppliers to enter.

As entry shifts supply outward, price falls toward the unchanged minimum long-run average cost. In the final long-run equilibrium, total industry output is higher because there are more firms. With identical cost curves and the usual assumptions, each firm returns to its minimum-average-cost scale. Thus a lasting increase in demand can raise total output without permanently raising price in this constant-cost benchmark. The path includes a temporary price rise that a comparison of only the initial and final equilibria would miss.

The horizontal long-run industry supply in this example reflects the constant-cost assumption. It is not the same object as an individual firm's horizontal demand curve. The firm's demand line says it takes the current market price as given. The industry's long-run supply says alternative market quantities can be supplied at the same long-run price after entry or exit and input adjustment. They may look alike geometrically while describing different actors and adjustment processes.

A decrease in demand reverses the broad sequence. Price falls in the short run; firms reduce output and may suffer losses. Some exit when they can avoid long-run commitments. Supply contracts until the remaining firms again cover the unchanged minimum long-run cost. Total industry output and the number of firms are lower, while the long-run price returns to its original level under these particular cost conditions.

Another way: Changing industry costs alter the long-run result

An expanding industry may bid up the prices of specialized workers, land or materials. If those higher input prices shift firms' cost curves upward, the industry is increasing-cost. After a demand increase and entry, the new long-run price can remain above the original price even though economic profit is again zero. The higher price covers higher opportunity costs. It is not necessarily evidence that entry failed to occur.

In a decreasing-cost industry, expansion can create external economies that reduce firms' costs, such as a thicker network of specialized suppliers. The long-run industry supply can then slope downward over the modeled range. These external industry effects should be distinguished from a single firm's internal economies of scale. An individual firm's cost curve can be U-shaped while industry expansion shifts the entire curve because input-market conditions change.

To determine the number of firms in the simplest identical-firm equilibrium, divide market quantity by the long-run output per firm. If demand at the long-run price is 240 units and each firm produces twelve, the model supports twenty firms. If the quotient is not a whole number and firms are indivisible, the continuous approximation may need refinement. A question requiring an exact finite number should supply compatible quantities or explicitly state how to handle the boundary.

Entry and exit also affect the interpretation of a policy. A fixed license fee may leave an incumbent's current marginal cost unchanged but reduce its economic profit and discourage future entry. A per-unit cost change can affect both current output and long-run participation. Distinguish which margin the policy changes. The short-run supply response and long-run market structure can differ even when they arise from the same initial intervention.

Finally, long-run equilibrium is not an ethical verdict on every firm's success or failure. It describes incentives within a model of opportunity costs and entry. A real industry can experience innovation, uncertainty and changing demand that prevent it from settling at a stationary point. The benchmark remains useful because it identifies the pressures at work. A responsible answer reports the direction of entry or exit, its effect on market supply, the assumed behavior of costs and the resulting price and output conditions, without presenting the adjustment as automatic in every observed market.

Another way: Check what the firm count assumes

Dividing market quantity by output per firm presumes identical firms operating at the specified scale. If some firms have lower costs, the same market quantity can be supplied by a different mix of outputs. A counted equilibrium also assumes that the market can support that number of operating firms without changing the cost curves. When a result depends on these restrictions, report them alongside the quotient rather than presenting the number as an institutional forecast.

5. Entry into a fictional badge-printing market

A fictional market initially contains identical badge printers. Each sells twelve batches at fifteen dollars per batch. Average variable cost is seven dollars, fixed economic cost is forty-eight and average total cost is eleven. Each earns forty-eight dollars of economic profit. The model permits new printers to enter with the same technology and assumes that more printers do not change material prices, wages or equipment costs.

Positive economic profit attracts entry. Market supply expands and price falls. If minimum long-run average cost is eleven dollars at twelve batches, the new long-run competitive price is eleven and each surviving identical firm produces twelve batches. Suppose market demand at that price is 240 batches. The long-run model then has twenty firms. The number follows from industry output divided by output per firm; it should not be confused with the twelve batches each firm produces.

Now revise one assumption: expansion raises the cost of specialized printing material, so minimum long-run average cost becomes thirteen dollars. Entry can still eliminate economic profit, but the final price is now thirteen rather than eleven. Zero profit does not require the old price to return when cost conditions have changed. The analyst must identify whether the industry is constant-cost or increasing-cost before making a price prediction.

The example also clarifies what zero profit means. At the final price, revenues cover the specified opportunity costs, including the normal return to owners' time and resources. The result does not imply unpaid labor or worthless equipment. It is a conditional equilibrium calculation for an invented market, not a forecast that real badge producers will reach an exact number or price. Actual entry delays and heterogeneous technologies would require additional modeling.

6. Check the tempting shortcut

Zero economic profit still covers opportunity costs and normal returns. A firm's output can fall while industry output rises through entry. The return to the original long-run price requires unchanged cost conditions; free entry alone does not guarantee it.

7. In the fictional Alder model, identical competitive firms initially each sell 11 units at 15 dollars. At that output AVC is 7 dollars and fixed cost is 44 dollars. Free entry is possible, products are identical, and industry expansion leaves input prices unchanged. Assume minimum long-run average cost is 11 dollars. Calculate current ATC, current economic profit per firm, and the model's long-run price after entry.

8. In the fictional Birch model, identical competitive firms initially each sell 12 units at 15 dollars. At that output AVC is 7 dollars and fixed cost is 48 dollars. Free entry is possible, products are identical, and industry expansion leaves input prices unchanged. Assume minimum long-run average cost is 11 dollars. Calculate current ATC, current economic profit per firm, and the model's long-run price after entry.

9. In the fictional Cedar model, identical competitive firms initially each sell 13 units at 15 dollars. At that output AVC is 7 dollars and fixed cost is 52 dollars. Free entry is possible, products are identical, and industry expansion leaves input prices unchanged. Assume minimum long-run average cost is 11 dollars. Calculate current ATC, current economic profit per firm, and the model's long-run price after entry.

10. In the fictional Dune model, identical competitive firms initially each sell 14 units at 15 dollars. At that output AVC is 7 dollars and fixed cost is 56 dollars. Free entry is possible, products are identical, and industry expansion leaves input prices unchanged. Assume minimum long-run average cost is 11 dollars. Calculate current ATC, current economic profit per firm, and the model's long-run price after entry.

11. Guided practice

In the fictional Elm model, identical competitive firms initially each sell 15 units at 15 dollars. At that output AVC is 7 dollars and fixed cost is 60 dollars. Free entry is possible, products are identical, and industry expansion leaves input prices unchanged. Assume minimum long-run average cost is 11 dollars. Calculate current ATC, current economic profit per firm, and the model's long-run price after entry.

12. Guided practice

In the fictional Dune model, identical competitive firms initially each sell 14 units at 15 dollars. At that output AVC is 7 dollars and fixed cost is 56 dollars. Free entry is possible, products are identical, and industry expansion leaves input prices unchanged. Assume minimum long-run average cost is 11 dollars. Calculate current ATC, current economic profit per firm, and the model's long-run price after entry.

13. Guided practice

In the fictional Fern model, identical competitive firms initially each sell 16 units at 15 dollars. At that output AVC is 7 dollars and fixed cost is 64 dollars. Free entry is possible, products are identical, and industry expansion leaves input prices unchanged. Assume minimum long-run average cost is 11 dollars. Calculate current ATC, current economic profit per firm, and the model's long-run price after entry.

14. Practice

In the fictional Grove model, identical competitive firms initially each sell 17 units at 15 dollars. At that output AVC is 7 dollars and fixed cost is 68 dollars. Free entry is possible, products are identical, and industry expansion leaves input prices unchanged. Assume minimum long-run average cost is 11 dollars. Calculate current ATC, current economic profit per firm, and the model's long-run price after entry.

15. Practice

In the fictional Harbor model, identical competitive firms initially each sell 18 units at 15 dollars. At that output AVC is 7 dollars and fixed cost is 72 dollars. Free entry is possible, products are identical, and industry expansion leaves input prices unchanged. Assume minimum long-run average cost is 11 dollars. Calculate current ATC, current economic profit per firm, and the model's long-run price after entry.

16. Somewhere new

Several new badge printers can enter a market using the same available equipment and supplies. The trade association wants to know whether existing profits persist when input prices stay fixed. Calculate the current margin and apply the stated long-run entry benchmark. In the fictional Island model, identical competitive firms initially each sell 19 units at 15 dollars. At that output AVC is 7 dollars and fixed cost is 76 dollars. Free entry is possible, products are identical, and industry expansion leaves input prices unchanged. Assume minimum long-run average cost is 11 dollars. Calculate current ATC, current economic profit per firm, and the model's long-run price after entry.

17. Lesson test

Lesson test: one question per skill, one attempt each, no hints. Your answers are checked when you submit.

18. Test question

In the fictional Juniper model, identical competitive firms initially each sell 20 units at 15 dollars. At that output AVC is 7 dollars and fixed cost is 80 dollars. Free entry is possible, products are identical, and industry expansion leaves input prices unchanged. Assume minimum long-run average cost is 11 dollars. Calculate current ATC, current economic profit per firm, and the model's long-run price after entry.

19. What you can do now

Reconstruct the model without the worked example. Explain each requested measure's units and identify an assumption that the conclusion depends on.

Working for the steps left to you

	Calculated value
Current ATC
Current economic profit
Long-run price

	Calculated value
Current ATC
Current economic profit
Long-run price

	Calculated value
Current ATC
Current economic profit
Long-run price

	Calculated value
Current ATC
Current economic profit
Long-run price