Question

6. Suppose a competitive market is in long-run equilibrium. How does the number of firms change if (i) Each firm's fixed costs decreases? Explain (ii) Each firm's marginal cost decreases? Explain (i) Demand decreases: for each price, consumers demand half of the amount as before? Explain

Answer 1

Solution 1

If the fixed costs decrease then the profitability of firms increase which will lead to increase in competitive market due to cost leadership and hence market turns into perfect competition

Solution 2

If the marginal cost decreases then the firms indulge in scalability of production and hence many firms are forced to exit necause of increasing supply by firms which have substantial balance sheet. Hence this turns the market into Oligopolistic market with few firms controlling market needs.

Solution 3

If demand for products decrease this leads to market failure and many firms loose out on revenues despite having achieved cost savings. Hence many firms either divest or hive off and hence few firms are left in market which leads to creation of differentiated products with no perfect substitute and which is characterized by monopolistic competition market structure .