Explain why a monopolistically competitive firm earns zero economic profit in the long run and show...

Explain why a monopolistically competitive firm earns zero economic profit in the long run and show graphically how they charge a higher price then perfectly competitive firms and are not cost efficient.

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Expert Solution

Ans) In monopolistic competition there are many sellers selling homogeneous but differentiated products. The element of selling differentiated products enables the seller to charge higher. The product can be differentiated in terms of quality or design or effectiveness. For eg- Gucci charges a lot higher than other brands selling similar products due to product differentiation.

Further, the barrier to entry in this market is low. This enable the firms to enter the market easily. If in short run, firms in the market earn positive economic profit, more firms will enter the market. This will increase the supply and competition and prices will drop. Therefore in long run, firms will earn zero economic profit.

Oppositely, if firms short run earn negative economic profit, some firms will leave the market, which will increase the price and firms will again come to a point where they earn zero economic profit.

Furthermore, monopolistic markets are inefficient because they charge higher and sell less quantity than socially desirable.

Monopolistic firm produces the quantity where MR and MC curve intersect and then charges the price on demand curve. And hence the price is a lot higher than the marginal cost.

Whereas in competitive markets, price is equal to marginal revenue and the quantity produced is more.

Rahul Sunny answered 7 months ago

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