Question

The question below is based on Four Market Structures. Why some firms might be able to continue to make an economic profit in the long-run? Discuss. Prepare between 2 to 4 pages or 500 to 1000 words for this discussion

Answer 1

Some firms are able to make Economic profits in the long run due to high barriers to entry and exit in that industry.

Among the four market structures, perfect competition and monopolistic competition are characterised by free entry and exit. The feature of free entry and exit ensures that all the firms in the industry earn normal Profits or zero economic profits i.e., just covering their costs.

If , in perfect competition, existing firms are earning economic profits in the short run, then new firms will get attracted to enter the industry and earn these economic profits. As such, new firms will enter the industry in the long run. As new firms will enter, the total supply of the industry will increase and market supply curve will shift to the right. This rightward shift of the market supply curve with an unchanged market demand curve will cause the equilibrium price to fall. As price will fall, profits will also fall. This entry of new firms will continue to take place until increased supply has reduced the price to such a level that all the economic profits of the firms are wiped off and all the firms in the industry earn normal Profits only i.e., just covering their costs in the long run.

If, in monopolistic competition, existing firms are earning economic profits, then new firms will get attracted to enter the industry to earn these economic profits. As such, new firms will enter the industry in the long run. As new firms will enter, the demand for existing firms will decrease and demand curve will shift to the left. This entry of new firms will continue to take place until the demand curve will become tangent to average total cost curve. When demand curve becomes tangent to average total cost curve it means that the price charged is just equal to average total cost indicating that all the firms earn normal Profits or zero economic profits i..e.,just covering their costs. Hence, firms in perfect competition and monopolistic competition do not earn Economic profits in the long run.

Market structures monopoly and oligopoly are characterised by high barriers to entry. High barriers to entry means that entry to the industry is restricted. As entry is restricted, no new firms will enter the Monopoly market or oligopoly market. As no new firms will enter, the existing firms will continue to sell the same level of output and charge the same high price. Had entry of new firms been possible, then it would have affected the demand and price of firms in the industry as in case of perfect competition and monopolistic competition. But, since monopoly and oligopoly are characterised by high barriers to entry, no new entry of firms take place . Hence, their market share of the output remains intact . Also, due to high barriers to entry, existing firms are able to influence the price of the product as no new firms enter and as such the consumer has limited choices( close substitutes are not available). As no close substitutes or no substitute ( as in case of monopoly) is available, the consumer has no choice but only to buy the product at the high price. Hence, monopoly and oligopoly exercise considerable power on the market price of the product. As such, they are able to earn Economic profits even in the long run.