Assume a firm in a monopolistically competitive industry is currently making a short run positive economic profit.

Assume a firm in a monopolistically competitive industry is currently making a short run positive economic profit. Describe what is likely to happen to this firm's profit in the long run. What role does elasticity play in this story?

Expert Solution

The monopolistic competitive market is characterized by many firms and large number of buyers and sellers, there is freedom of entry and exit in the market, differentiated products as well.

If the firm is making positive profits in the short run, in the long run they would be earning zero economic profit. This is because there is freedom of entry and exit for the firms so other firms will be attracted by the positive profits and will enter into the market. And this will decrease demand for the existing firm , the new firms keep coming into market until the economic profits equals zero.

The firms can still earn if the price elasticity of demand is inelastic, this is more likely. The firms are producing differentiated products so some of may get accustomed to it or got a psychological feeling to it , in these situations the demand will be inelastic so the firms does have a control over the price. If the demand is highly inelastic, this acts as a barrier to the new firms so few firms will come into the market and may enjoy some positive profits in the long run as well.

Rahul Sunny answered 2 years ago

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