Question

Which of the following statements best describes the long run adjustment in a monopolistic competition market that has short-run profit?

One or more competitors closes, increasing the demand for the output of an existing seller in the monopolistic competition. The existing seller’s profits increase and positive profit is sustained in the long run.

One or more competitors opens, reducing the demand for the output of an existing seller in the monopolistic competition. The existing seller’s profits decline and the seller incurs losses and exits the industry in the long run.

One or more competitors closes, increasing the demand for the output of an existing seller in the monopolistic competition. The existing seller’s profits increase until there is zero profit in the long run.

One or more competitors opens, reducing the demand for the output of an existing seller in the monopolistic competition. The existing seller’s profits decline and the seller earns zero profit in the long run.

Answer 1

Answer- one or more competitors open, reducing the demand for the output of an existing seller in the monopolistic competition. The existing seller's profit declines and the seller earns zero profit in the long run.

Explanation- If existing firms in monopolistic competition are earning short run profits, then new firms will be attracted to enter the industry and earn these profits. As new firms enter, the existing firms demand for output reduces. As demand reduces, profits also reduce and the seller earns zero profit in the long run. The seller earns normal profits only i.e., just covering their costs.

Graphically, as new firms enter, the demand curve of existing firm shifts to left until it becomes tangent to average total cost of the firm. When demand curve will be tangent to average total cost curve then price charged will be equal to average cost and existingexisting firm would earn zero profits. They will earn normal profits only i.e., just covering their costs.

Option a is incorrect because as monopolistic market that has short run profit will induce new firms to enter the industry to earn these profits. As such no competitor will close or exit the industry.

Option b is incorrect because profits of existing firms will decline as new firms will enter the industry, but it will not result in negative profits or losses. The entry of new firms will result in decrease in demand for output of existing firm and profits will reduce to such a level that existing firms earn normal profits only i.e., just covering their costs.

Option c is incorrect because short run profit will attract new firms to enter the industry and no existing firms will exit the industry. Firms exit when losses are incurred. Short run profit will induce new firms to enter the industry.