Answer to Question #31304 in Economics of Enterprise for Ann
2, The following graph shows a firm in a monopolistically competitive industry.
a. Show the firm's short-run profit-maximizing quantity and price. Is the firm making a profit? (See attachment for Graph F)
b. Carefully explain what will happen in the industry over time, and draw a graph of a
monopolistically competitive firm in lon-run equilibrium.
In the long run, monopoly competitive firms will earn zero profit.
When existing firms in an industry make profits, it encourages other firms to enter the market. As a result, the demand from each firm decreases because consumers have more products to choose from. When existing firms make losses, other firms exit the market, and the demand curve shifts to the right. The remaining firms see increasing profits. Exit and entry continues until long run equilibrium is reached. At this point,firms are making zero profit, and there is no incentive to enter or exit the market. Price minus average total cost equals profit per unit. Maximum profit is zero only when the average total cost curve is tangent to the demand curve. This tangent point occurs at the exact quantity where MR=MC. Like in a monopoly market, a monopolistic competitor sells at a price that exceeds marginal cost. Like in a competitive market, price equals average total cost because entry and exit push the profit to zero. Monopolies can earn profit in the long run, but the long run profit for monopolistic competitors is zero because of free entry and exit.