Question

Is it true in the long-run, a firm under monopolistic competition has market power but earns no profit? Explain.

Answer 1

In the terms of production and supply, long-run is the time period when all features of production are changeable and can consequently be altered to meet shifts in demand. The suppliers in monopolistic competitive markets are price makers and will behave the same way in the long-run. Same like a monopoly, a monopolastic competitive firm will maximize its profits by producing goods to the point where its marginal revenues will equal its marginal costs. In the long-run, the demand curve of a firm in a monopolistic competitive market will move so that it becomes tangent to the firm’s average total cost curve. Consequently, this will not be possible for the firm to make economic profit; it will just be able to break even. In the long-run, a monopolistic competitive market is ineffective. It does not attain allocative and productive effectiveness. Besides, since a monopolistic competitive firm has the control over the market that is alike to a monopoly, its benefit maximizing level of production will result in a net loss of consumer and producer excess. A firm which is making surplus or gain in the short run will nevertheless break even in the long run since demand will reduce and average total cost will rise. This means that in the long run, a monopolistic firm will make zero profit. The entry of new firms follows to a rise in the supply of distinguished products, that causes the firm's market demand curve to shift to the left. As entry into the market rises, the firm's demand curve will go on shifting to the left unless it is tangent to the average total cost curve at the profit maximizing level of output. At this point, the firm's profits are zero, and there is no longer any inducement for new firms to come into the market.