Question

Assume Health-R-Us is a legal monopoly: it is a monopoly due to legal protection from the government in the form of a patent issued to the company. Imagine that the government withdraws the legal protection for Health-R-Us such that the market becomes competitive. Will a typical individual firm in this competitive market make economic profit in the long run? Why or why not? Use an appropriate firm-level diagram to illustrate and explain your answer?

Answer 1

If the market becomes competitive, Health-R-Us will not make economic profit in the long run. A typical firm in perfect competition makes zero economic profit.

reason: When the market becomes competitive, more firms will enter the market. As the government has removed the protective ban on entry to the market, short run positive profits will attract many firms to the market. The entry of these new firms will exert a downward pressure on equilibrium price and price will decrease.

The price is uniform in the competitive market and all firms are price takers. However, costs are different for different firms. Those firms for whom the prevalent price is equal to ATC will make zero economic profits. If the price stands below ATC (but above AVC), the firms will recover only the cost of production. But if the price falls below AVC, the firms will shut down production temporarily till the price increases. Price will increase because there will be decrease in the quantity of goods when some firms shut down production. But if the increased price is still below AVC (or if price does not increase), in the long run, firms will exit the market.

Graph:

  

This is the cost curve of Health-R-Us. The firm is in long run equilibrium. The market price is equal to ATC and it is making zero economic profit.