Q.How is the equilibrium number of firms determined in a market where entry and exit is permitted?

In a perfectly competitive market where entry and exit are free, the equilibrium number of firms is determined by the condition that all firms earn zero economic profit in the long run.

Here is the logic step by step. If existing firms earn supernormal profit (price > average cost), new firms enter the market. This shifts the market supply curve to the right, lowering the market price. Entry continues until price falls to the minimum point of each firm’s average cost curve — the break-even point. Conversely, if firms incur losses (price < average cost), some firms exit. Supply shifts left, price rises, and exit stops when price again equals minimum average cost.

At this long-run equilibrium:

• Each firm produces at the output level where $P = MC = \min(AC)$.
• The market price is fixed at this minimum average cost.
• The total quantity demanded in the market at that price is determined by the market demand curve.
• The equilibrium number of firms is then: …

The key insight here is that when firms can freely enter or leave a market, the number of firms is not fixed by any external rule. Instead, it adjusts naturally through the profit motive. Think of it as a self-correcting mechanism: profits attract new firms, losses drive existing ones away, and the process continues until no firm has an incentive to either enter or exit.

Why zero profit is the equilibrium condition

In economics, "profit" here means economic profit — total revenue minus both explicit and implicit costs, including the opportunity cost of the entrepreneur's time and capital. When economic profit is positive, outsiders see an opportunity and enter the market. When it is negative, firms exit to avoid losses. Only when economic profit is zero does the market stabilise.

The role of the cost curves

For zero profit to hold, price must equal average cost ($P = AC$). But that alone is not enough — if price equals AC at a point where AC is still falling, a firm could increase output and lower its average cost, earning positive profit. So the equilibrium must also be at the minimum of the average cost curve, where $MC = AC$. At this point, the firm is producing at its most efficient scale.

How the number of firms adjusts

Start from a situation where there are too few firms. Demand exceeds supply at the prevailing price, so price rises above minimum AC. Existing firms earn positive economic profit. This attracts new entrants. As more firms enter, market supply increases, which pushes the price down. Entry continues until price falls back to minimum AC and profits return to zero. …