Answer to Question #210750 in Microeconomics for Rolin Simo

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? (Max. 1000 words)

 

Answer 1

If the demand function is cutting through the average total cost curve then it implies that it will be cutting it at a two different points which indicates that the price is equal to average total cost at two different locations.This cant be possible because there is only one break even the price at which it's equal to average total cost and the profit will be zero.

Since the price equal to average total cost gives zero, economic profit at a particular location there will be no incentive for any other form to enter the market and bring the price down. Hence this will make the demand is always tangent to the average total cost in monopolistically competitive market in the long run.