Answer to Question #121120 in Microeconomics for Aman

Question

Draw a properly labelled diagram showing profit for a monopolistic
competitive firm.
(b) Explain with the help of a diagram that the representative firm in a monopolistic competitive market makes only normal profits in the long run.
(c) ​Compare and contrast the equilibrium of a perfectly competitive firm and a monopolistic competitive firm in the long-run.

Answer 1

a) In the short run, the monopolistic firms maximize profits by producing quantities at the point marginal revenue is equal to marginal cost (MR=MC). The monopolistic competitive firm earns a positive economic profit as long as the average total cost (ATC) is below the market price. 

b) Long run monopolistic competitive firm

The positive economic profits earned by the monopolistic competitive firms in the short run attract other firms to enter the market and consequently, this lowers the profits earned. Ideally, more firms continue to enter the market until the monopolistic firms earns only a normal profit in the long run. 

c)Long run monopolistic firm and perfect competitive firm

In a perfect competitive market in the long-run, all firms receive normal profits or zero economic profits which is the same case for the monopolistic firm in the long run. However, if the firms become to many, the monopolistic firm in the long run may incur loses and exit the market. For the perfect competitive firm, prices are set by the forces of demand and supply. Entry of new firms will drive down prices and result in increase in supply as the costs go up even as competition increases. The price will be equal to the average cost and only normal profits will be earned by the perfect competitive firm.