Question

Consider a constant-cost competitive industry that is initially in long-run equilibrium. If there is an increase in demand in this industry, which of the following do we expect to observe in the new long-run equilibrium (compared to the initial equilibrium)?

a. Firms are making positive economic profits.

b.Each firm in the market is producing a larger quantity.

c. The market price will be higher.

d. There will be a larger number of firms in the industry.

e. None of the above

Could you explain why others are incorrect as well? Thank you!

Answer 1

d. There will be a larger number of firms in the industry.

(An increase in demand will increase price and quantity which will cause positive economic profits. But in the long run, each firm earns zero economic profits, so, option a is wrong. As it is a constant cost competitive industry, soin long run price will be same. So, option c is wrong. Due to positive profits, more firms will enter the industry, which will increase the number of firms in the industry and thus option d is correct. This will increase the supply and thus price will decrease to long run level and market quantity will increase. However, quantity produced by individual firms may increase or decrease.)