A Firm Can Earn Economic Profits in the Long Run

Learning Objectives

• Explain how short run and long run equilibrium bear on entry and leave in a monopolistically competitive manufacture

Monopolistic Competitors and Entry

A monopolistic competitor, like firms in other market structures, may earn profits in the short run, but that doesn't mean they'll be able to keep them. If one monopolistic competitor earns positive economic profits, other firms will be tempted to enter the market. A gas station with a not bad location must worry that other gas stations might open up across the street or downward the route—and perhaps the new gas stations will sell java or take a carwash or some other attraction to lure customers. A successful restaurant with a unique barbecue sauce must be concerned that other restaurants will endeavour to copy the sauce or offer their ain unique recipes. A laundry detergent with a smashing reputation for quality must be concerned that other competitors may seek to build their own reputations.

The entry of other firms into the aforementioned full general market (similar gas, restaurants, or detergent) shifts the need curve faced by a monopolistically competitive firm. Equally more than firms enter the market, the quantity demanded at a given price for whatsoever particular firm volition turn down, and the firm'south perceived need curve volition shift to the left. As a business firm'due south perceived need curve shifts to the left, its marginal revenue curve volition shift to the left, as well. The shift in marginal revenue will modify the turn a profit-maximizing quantity that the business firm chooses to produce, since marginal acquirement will then equal marginal cost at a lower quantity.

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Earlier we dive deeper into an explanation virtually why firms enter or go out in a monopolistically competitive industry, pace through these slides to meliorate understand how changes in demand lead to changes in the market.

Now nosotros'll step through the above activity in more detail. Figure ane(a) shows a state of affairs in which a monopolistic competitor was earning a turn a profit with its original perceived demand curve (D₀). The intersection of the marginal revenue curve (MR₀) and marginal cost curve (MC) occurs at bespeak S, corresponding to quantity Q₀, which is associated on the need curve at indicate T with price P₀. The combination of price P₀ and quantity Q₀ lies to a higher place the boilerplate toll curve, which shows that the business firm is earning positive economic profits.

Figure 1. Monopolistic Competition, Entry, and Get out. (a) At P₀ and Q₀, the monopolistically competitive business firm in this effigy is making a positive economic profit. This is articulate because if you follow the dotted line in a higher place Q₀, you can see that price is higher up average toll. Positive economic profits attract competing firms to the industry, driving the original firm'southward demand downwards to D_i. At the new equilibrium quantity (P_i, Q₁), the original house is earning zippo economical profits, and entry into the industry ceases. In (b) the reverse occurs. At P₀ and Q₀, the firm is losing money. If yous follow the dotted line higher up Q₀, yous can see that average cost is above price. Losses induce firms to leave the industry. When they do, demand for the original business firm rises to D₁, where once once again the firm is earning cypher economical profit.

Unlike a monopoly, with its high barriers to entry, a monopolistically competitive firm with positive economical profits volition attract competition. When some other competitor enters the market, the original firm's perceived need curve shifts to the left, from D₀ to D₁, and the associated marginal revenue curve shifts from MR₀ to MR₁ (every bit shown in figure 1a). The new profit-maximizing output is Q_i, because the intersection of the MR₁ and MC at present occurs at point U. Moving vertically up from that quantity on the new need curve, the optimal price is at P₁.

As long as the firm is earning positive economical profits, new competitors will continue to enter the market, reducing the original house'south demand and marginal acquirement curves. The long-run equilibrium is shown in the figure at point 5, where the firm's perceived demand bend touches the average cost curve. When price is equal to boilerplate cost, economic profits are zero. Thus, although a monopolistically competitive firm may earn positive economic profits in the short term, the process of new entry will bulldoze downwards economical profits to zero in the long run. Recall that zero economic profit is not equivalent to nil bookkeeping profit. A zero economic profit means the firm's accounting profit is equal to what its resources could earn in their side by side all-time apply. Figure 1(b) shows the reverse state of affairs, where a monopolistically competitive firm is originally losing money. The adjustment to long-run equilibrium is coordinating to the previous example. The economic losses lead to firms exiting, which volition result in increased demand for this particular business firm, and consequently lower losses. Firms exit upwardly to the point where there are no more losses in this market, for example when the demand curve touches the average toll curve, equally in point Z.

Monopolistic competitors tin make an economical profit or loss in the brusk run, but in the long run, entry and exit will drive these firms toward a zero economic profit issue. However, the cipher economical turn a profit outcome in monopolistic competition looks dissimilar from the zilch economical turn a profit effect in perfect competition in several ways relating both to efficiency and to diverseness in the market.

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Lookout Information technology

This video demonstrates the graph for a monopolistic competitive house. In the short run, the graph looks like but like the graph for a monopoly, with the house making an economic profit. In the long run, nonetheless, firms will enter the industry and crusade the demand curve to shift to the left, which results in no economical profit.

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These questions allow you to go equally much practice as y'all need, as you can click the link at the summit of the first question ("Try another version of these questions") to become a new prepare of questions. Practise until y'all feel comfy doing the questions.

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Source: https://courses.lumenlearning.com/wmopen-microeconomics/chapter/entry-exit-and-profits-in-the-long-run/

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