A shift in demand curve has a larger effect on price and smaller effect on quantity when the number of firms is fixed compared to the situation when free entry and exit is permitted. Explain.

In short run the number of firms is fixed where as in long run the number of firms is not fixed.

Now with help of following two graphs we will explain the effect in short run market –

In short run, when number of firms is fixed –

Graph 1.1 - DD represents the demand curve and E is the initial equilibrium, where demand and supply intersect each other.

Now when the demand increases the demand curve shifts to D1D1, new equilibrium E1 arises where supply curve and demand curve intersect each other at price P1 and equilibrium quantity Q1. This means both equilibrium price and quantity rises.

Graph 1.2 - DD represents the demand curve and E is the initial equilibrium, where demand and supply intersect each other.

Now when the demand decreases the demand curve shifts to D2D2, new equilibrium E2 arises where supply curve and demand curve intersect each other at price P2 and equilibrium quantity Q2. This means both equilibrium price and quantity falls.

Now with help of following two graphs we will explain the effect in long run market –

In long run, when number of firms is not fixed, but free entry and exit is allowed –

Graph 2.1 - DD represents the demand curve and E is the initial equilibrium, where P = Min AC

Now when the demand increases the demand curve shifts to D1D1, new equilibrium E1 arises where price is same and equilibrium quantity is Q1. This means equilibrium price remains same but equilibrium quantity rises.

Graph 2.2 - DD represents the demand curve and E is the initial equilibrium, where P = Min AC.

Now when the demand decreases the demand curve shifts to D2D2, new equilibrium E2 arises where price is same and equilibrium quantity is Q2. This means equilibrium price remains same but equilibrium quantity falls.

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