| Sumario: | An explanation of the rise and fall of firms' output levels is not sufficient to account for the changes in the quantity produced by an entire industry, since these will often be accompanied by changes in the number of firms. It seems plausible that the factors governing the creation or annihilation of a firm are somewhat different from the factors which govern the adjustment of an existing firm's output level to changes in demand or cost conditions. The latter type of adjustment depends on demand and cost functions and perhaps on some assumptions about the behaviour of competing firms as in the Cournot model; the former type of adjustment may also depend on the magnitude of the reward that can be expected upon entry into the industry. The treatment of the problem of entry and exit is seldom formalized. The typical argument in the case of perfect competition is as follows: if firms in the industry are making profits in excess of normal profit, new entrepreneurs will be induced to enter the industry. Their entry shifts the industry supply curve to the right and the market price falls. Each firm in the industry then reduces its output and profits fall. The process continues until profit in excess of normal profit becomes zero. Similarly, if losses are being incurred some entrepreneurs leave the industry, the aggregate supply is reduced, market price rises and profits rise to zero. The equilibrium number of firms is determined by the condition that profit equal zero ([3, pp. 96-8, 192-5]).
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