Question

What factors prevent firms in monopolistic competition to earn economic profits in the long run? Discuss the adjustment process and factors such as customer or brand loyalty that might slow the adjustment process?

Answer 1

In a monopolistically competitive market there are very low barriers to entry and exit in the market . So if the firms are earning positive economic profits in short run , new firms are attracted towards the market . In the long run many new firms will enter . The entry of new firms leads to an increase in the supply of differentiated products in the market , which causes an individual firm's market demand to fall . As entry into the market increases, the firm's demand curve will continue shifting to the left or demand will continue to fall until it is just tangent to the average total cost curve at the profit maximizing level of output . At this stage the economic profit becomes zero and no new firms enter the market .

This adjustment process is slowed down when there is customer or brand loyalty . This is because due to special customer preferneces some firms gain market power or monopoly in these markets . Even if there are thousand other brands producing the same goods , custormer prefer this brand so much that its demand does not fall in long run .