Q.At what level of price do the firms in a perfectly competitive market supply when free entry and exit is allowed in the market? How is equilibrium quantity determined in such a market?

In a perfectly competitive market with free entry and exit, firms supply at a price equal to the minimum of their long-run average cost (LAC). At any price above minimum LAC, supernormal profits attract new firms into the market, increasing supply and pushing price down. Conversely, if price falls below minimum LAC, losses force firms to exit, reducing supply and raising price back up. This process continues until price settles at minimum LAC, where firms earn only normal profit (zero economic profit) and there is no incentive for entry or exit. …

The Long-Run Price: Why Minimum Average Cost?

The defining feature of a perfectly competitive market with free entry and exit is that firms can respond to profit signals without barriers. This mobility drives a powerful adjustment mechanism.

When price exceeds the minimum long-run average cost, existing firms earn supernormal profits (revenue above all costs, including opportunity costs). These profits act as a beacon: new firms enter the market, attracted by the above-normal returns. As more firms enter, market supply shifts rightward, pushing price down. Conversely, when price falls below minimum LAC, firms incur losses. Some exit the market, reducing supply and nudging price back up.

This entry-exit process continues until price settles exactly at the minimum point of the long-run average cost curve. At this price, firms earn only normal profit—just enough to cover all explicit and implicit costs, including the opportunity cost of capital and entrepreneurship. There is no incentive for further entry (no supernormal profit to attract newcomers) and no incentive to exit (firms are covering all costs). The market reaches a stable equilibrium.

Each firm produces at the output level where its LAC is minimized, operating at the most efficient scale. The firm's marginal cost equals both price and minimum LAC at this point: $P = MC = \text{min LAC}$.

Determining Equilibrium Quantity

Once we know the equilibrium price (minimum LAC), the equilibrium quantity in the market follows from the intersection of market demand and the long-run market supply curve.

The long-run market supply curve in a constant-cost industry is perfectly elastic (horizontal) at the price equal to minimum LAC. Why horizontal? Because at any price above minimum LAC, infinite entry would occur; at any price below, infinite exit would happen. The only sustainable price is exactly minimum LAC, and at that price, the market will supply whatever quantity is demanded.

The equilibrium quantity is determined by the market demand curve at this price. If market demand is $Q_d = f(P)$, then substituting $P = \text{min LAC}$ gives the equilibrium quantity $Q^*$. This quantity represents the total output supplied by all firms in the market.