Answer to Question #208438 in Microeconomics for Kyle

Question

Why is it the case in a long-run monopolistically competitive equilibrium that the firm’s demand curve is tangent to its average cost curve? Why could it not be a long-run equilibrium if the demand curve “cut through” the average cost curve?

Answer 1

If the demand function is cutting through the average total cost curve then it implies that it will be cutting it at two different points. this would indicate that price is equal to average total cost at two different locations. this is not possible because there is only one break even price at which the price is equal to average total cost and the profit is zero'

If price equal to average total cost gives us zero economic profit at one location there is no incentive for any other form to enter the market and bring the price further down so that there is an economic loss. Hence demand is always tangent to the average total cost in monopolistically competitive market in the long run.