Question

Assuming that external economies exist, when demand increases in a perfectly competitive market, in the long-run, the price of the product:

• A. rises above the initial price (before the demand increase) and quantity increases
• B. remains the same as the initial price (before the demand increase) and quantity increases
• C. falls below the initial price (before the demand increase) and quantity increases
• D. equals the initial price (before the demand increase) and quantity decreases

Hint:

In perfectly competitive markets with external economies, the long-run adjustment typically leads to a return to the original price level, but with a higher quantity of output due to increased market supply.

Answer 1

The Correct Option is C

External economies refer to benefits that firms experience due to the growth of the industry or sector, even without increasing their own individual production. In the case of a perfectly competitive market, when demand increases, firms in the market will initially respond by producing more, and the price of the product will likely rise in the short term. However, in the long run, the entry of new firms into the market (due to the absence of barriers to entry) will increase the total supply of the product. This increased competition causes the price to fall back to the original equilibrium price, assuming that the market reaches a new equilibrium with more firms. The quantity, however, will continue to increase as new firms enter the market and increase the total quantity supplied. Step 1: Analyze the short-term impact. 
In the short term, the demand increase raises the price and encourages more production, but in the long run, the market adjusts as new firms enter. Step 2: Long-term equilibrium. 
In the long run, with increased competition and the entry of new firms, the price falls back to the initial level. The quantity, however, will continue to increase due to the higher number of firms producing the good. Thus, the correct answer is (C), which indicates that in the long run, the price falls back to the original level while quantity increases. 
Final Answer:falls below the initial price (before the demand increase) and quantity increases}