How does a free market encourage competition?

• A. By setting government-imposed price controls to regulate firm behavior
• B. By allowing firms to freely enter and exit the market, leading to more choices for consumers
• C. By granting monopolies to selected firms to ensure stability
• D. By restricting the number of firms through licensing requirements

Answer: (B)

Verified step by step guidance

1. Understand the concept of a free market: it is a market system where prices and production are determined by unrestricted competition between privately owned businesses, without government-imposed controls.
2. Recognize that competition in a free market arises because firms can freely enter or exit the market based on profitability, which encourages innovation and efficiency.
3. Note that when firms can enter freely, new competitors challenge existing firms, leading to more choices and better prices for consumers.
4. Contrast this with government-imposed price controls or licensing restrictions, which limit competition by restricting firm behavior or the number of firms.
5. Conclude that the key mechanism by which a free market encourages competition is through the freedom of entry and exit, fostering a dynamic environment where firms compete to attract consumers.