Market Equilibrium Free Entry and Exit

Introduction: What is a market?

A market is a place where buyers and sellers can exchange items for a price. There are two types of markets, physical markets such as those containing retail stores, and virtual markets such as online stores. In the case of virtual markets, no physical interaction between the buyers and sellers takes place while in the case of physical markets, the buyers and sellers have interactions.

Economic transactions should take place in the marketplace for a place to be called a market. Transactions may be of various types and may include goods, services, currency, or information apart from any other combination of any of these items. The ownership of things should pass from one person to another in a market.

A minimum of two parties must be there in a market for a trade. However, a third party is also required to instill competition and keep balance in the transactions of a market. A market in perfect competition usually has a large number of buyers and sellers.

The term ‘market’ can usually represent a variety of things based on the context.

For example, stock markets are places where securities are traded. There may also be special entities in the market such as the housing markets. The term may also indicate a broad and worldwide industry such as the diamond market of the world.

The term market economy is a concept that is used to indicate ideas that help shape the markets. In such a concept, the market is controlled by demand and supply. The market economy is an open market system where the participants are free to choose, buy, and sell any item. Although most market economies have little government intervention, the state of intervention is often very low. Some examples of market economies include the US, the UK, and Japan markets. In these markets free entry and exit are applicable.

What is Market Equilibrium?

Market equilibrium is a condition where the demand and supply of the market are mutually balanced. Usually, when over-supply occurs in a market, the prices of the product go down which increases the demand. On the other hand, when there is an over-demand, the prices go up which diminishes the demand.

The price at which supply and demand balance in a market is known as the equilibrium price. The periodic consolidation of a market index or its sideways momentum usually indicates market equilibrium over a certain period of time.

The prices of a product often hover over the equilibrium price level instead of being constant. When the prices go too down, buyers buy products more than usual which increase demand and price while in the case of a price rise, the buyers buy less, and hence price comes down.

Market Equilibrium Free Entry and Exit

There is a theoretical concept of market equilibrium where the number of firms is fixed. Although there is nothing wrong with the concept, it is impossible to find such markets because there is no such market in reality. In most markets, there is free entry and exit of firms.

There is a barrier to entry in economic and physical terms, but firms that are able to meet these barriers can easily enter a new market. For companies that cannot meet the entry requirements cannot enter new markets.

Exit is, however, possible for any firm at any given instant. Most firms exit markets when there is no plausible demand for their products or when there is no demand for their products in the markets which leads to depleting revenues and profitability.

The preliminary assumption while considering market equilibrium in the case of free entry and exit is that no firm earns a superannuation profit or an extreme loss while it is in production of a firm. This assumption is important because if too much gain incurs, there will be only entry and no exit which is also the case when only exit occurs when there is an acute loss.

Now, let’s assume that a market with free entry and exit has a supernormal profit.

• This will attract many new players which will evenly distribute the profits among the market players. In other words, profitability will come down to a normal level when there is a free entry of firms in a super-normally profitable market.

• When new companies enter into a market with supernormal profits, the demand will remain the same but the supply curve will shift rightward. This will result in a decrease in the product’s market cost price. When the price goes down, the profitability arising from the product will go down which will bring the supernormal profitability down to a normal level.

• When profits come down, some firms will find it less alluring to remain in the market and they will exit the market. In such a situation, the number of firms in the market will go down. So, the amount of profit earned on average will go up and reach the normal point.

• So, in the case of market equilibrium where free entry and exit are possible for firms, there is always a normal profit that can be earned from the market. However, there are instances where firms outcompete other firms in the market to earn supernormal profits even when the market is fully in equilibrium. However, in general, the conditions of market equilibrium in the case of firms that can enter and exit a market freely, the profitability stays within limits.

• We can assume that there is a limit of firms in the market that produce similar goods because too many or too few firms invite fluctuations in profitability. That is why it is recommended that a market has a finite number of players at any given instant. The concept of market equilibrium fixed number of firms is more about demand and supply, the market equilibrium free entry and exit concept is more about profitability.

Conclusion

Market equilibrium where firms can enter and exit freely is a matter of study for most economists and businessmen because it is related more to real-market economics than the concept of market equilibrium of a fixed number of firms. However, one must notice that like in the case of a fixed number of firms, there are a few assumptions in the case of free entry and exit too. Still, it is nonetheless important to study the concept by one and all.

FAQs

Qns 1. What is a market? How many types of markets are there?

Ans. A market is a place where buyers and sellers can exchange items for a price. There are two types of markets, physical markets such as those containing retail stores, and virtual markets such as online stores.

Qns 2. What is market equilibrium? Discuss with the concepts of supply and demand.

Ans. Market equilibrium is a condition where the demand and supply of the market are mutually balanced. Usually, when over-supply occurs in a market, the prices of the product go down which increases the demand. On the other hand, when there is an over-demand, the prices go up which diminishes the demand.

Qns 3. What is meant by free entry and exit of firms?

Ans. Free entry and exit refer to the lack of barriers to entry and exit in a market where firms can enter and exit the markets as they wish.