Answer to Question #273079 in Microeconomics for hgh

Question

 (5 marks) Diya opens a cake shop in her locality. At the time, her cake shop is the only one in the locality and she manages to maximise her profits. After six months, several new cake shops are opened in the locality, each of which specialises in a cake of a different flavour. How does the entry of new cake shops affect Diya’s cake shop if she still aims to maximise profits? Explain your answer using a graph that shows the change.

Answer 1

Competition among businesses can lead to the development of new or improved products, as well as more efficient operations. Consumers gain from new and better products, and innovation contributes to economic growth and higher living standards. In an ideal world, competition between new and established businesses leads to the survival of the fittest. Even if overall employment is declining, new businesses can boost productivity. When the employment effect is dominated by the displacement of existing enterprises (region II of the "wave" displayed), the productivity-enhancing effect of business formation occurs in the medium term. First, new enterprises create market rivalry, reducing incumbent firms' market power and pressuring them to become more efficient or go out of business. Second, only companies who have a competitive edge or are more efficient than incumbents will enter the market. As a result of the subsequent selection process, less efficient enterprises are forced to exit the market.