Question

Consider a competitive market with a large number of identical firms. The firms in this market do not use any resources that are available only in limited quantities. In this market, an increase in demand will _________.
a. increase price in the short run but not in the long run.
b. increase price in the long run but not in the short run.
c. increase price both in the short and the long run.
d. not affect price in either the short or the long run.

Answer 1

Answer:

a. increase price in the short run but not in the long run.

Explanation:

A perfectly competitive market is one in which firms in an economy produce similar goods, and use resources that are limited in quantity.

An increase in demand will result in a corresponding increase in price, and results in firms making high profits. In the diagram below it results in a shift of demand from D1 to D2.

In the long run as firms have low barrier to entry more firms enter the market and supply shifts from S1 to S2. There is reduction in prices and profits start to fall. This is illustrated in the second diagram.