Question 1

Why do firms earn zero economic profit in long-run equilibrium under monopolistic competition?

Accepted Answer

In long-run equilibrium, new firms enter the market when existing firms earn short-run profits, increasing competition and shifting demand curves leftward. This process continues until each firm's demand curve becomes tangent to its average total cost curve, where marginal revenue equals marginal cost. At this point, firms break even, earning zero economic profit while still covering all costs including normal return on investment.

Question 2

What happens to the demand curve when firms enter a monopolistically competitive market?

Accepted Answer

When new firms enter the market attracted by short-run profits, they increase competition and dilute demand for each existing firm's differentiated product. The demand curve for each existing firm shifts leftward as customers distribute their purchases among more competitors. This leftward shift continues until the demand curve becomes tangent to the average total cost curve at equilibrium.

Question 3

How does excess capacity relate to long-run equilibrium in monopolistic competition?

Accepted Answer

Excess capacity occurs because firms operate at a point on their demand curve that is tangent to the average total cost curve, but not at the minimum point of the ATC curve. This means firms are not producing at the lowest possible cost per unit. The equilibrium output is lower than the most efficient production level, resulting in higher per-unit costs compared to perfect competition.

Question 4

Why is price greater than marginal cost in monopolistic competition's long-run equilibrium?

Accepted Answer

At long-run equilibrium, firms set prices based on their downward-sloping demand curve where marginal revenue equals marginal cost. Because the demand curve slopes downward, the price at this equilibrium point exceeds marginal cost. This price-cost gap reflects the firm's market power from product differentiation and indicates allocative inefficiency, as resources are not optimally allocated from society's perspective.

Question 5

What role does firm exit play in reaching long-run equilibrium?

Accepted Answer

If firms incur losses, they exit the market, reducing supply and competition. This allows remaining firms to increase their market share and raise prices until they break even. The exit process mirrors the entry process and continues until no firms have incentive to leave, achieving a stable equilibrium where all remaining firms earn zero economic profit.

Question 6

How does long-run equilibrium differ from short-run equilibrium in monopolistic competition?

Accepted Answer

Short-run equilibrium allows firms to earn supernormal or negative profits depending on market conditions. Long-run equilibrium is reached only when entry and exit have adjusted firm numbers so all firms earn zero economic profit. The freedom of entry and exit ensures that long-run equilibrium represents a stable market condition where no firm has incentive to enter or leave the industry.

Question 7

Why do firms continue product differentiation and advertising despite earning zero economic profit?

Accepted Answer

Although firms earn zero economic profit in long-run equilibrium, they still earn accounting profit and maintain market share through ongoing non-price competition. Product differentiation and advertising help firms preserve their customer base and create opportunities to earn short-run profits before new competitors respond. This behavior reflects the dynamic nature of monopolistically competitive markets where firms constantly compete on product features and brand identity.

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