What is
the reason for the long run equilibrium of a firm in monopolistic
competition to be associated with zero profit?
What is the reason for the long run equilibrium of a firm in monopolistic competition to be associated with zero profit?
The long
run time horizon is featured by the free entry and exit of firms. If
the firms in the short run are earning abnormal or super normal
profits, then, new firms will be attracted to enter the market. Due
to the new entrants, the market supply will increase. It leads to the
reduction in the price that ultimately falls sufficiently to become
equal to the minimum of average cost. When the market price is equal
to the minimum of AC, it implies that all the firms earn normal
profit or zero economic profit.
On the
contrary, if in the short run the firms are earning abnormal losses,
then the existing firms will stop production and exit the market.
This will lead to a decrease in the market supply, which will
ultimately raise the price. The price will continue to rise until it
becomes equal to the minimum of AC. ‘Price = AC’ implies
that in the long run all the firms will earn zero economic profit.
Hence,
when the price is equal to the minimum of AC, neither any existing
firm will exit nor any new firm will enter the market.
The long run time horizon is featured by the free entry and exit of firms. If the firms in the short run are earning abnormal or super normal profits, then, new firms will be attracted to enter the market. Due to the new entrants, the market supply will increase. It leads to the reduction in the price that ultimately falls sufficiently to become equal to the minimum of average cost. When the market price is equal to the minimum of AC, it implies that all the firms earn normal profit or zero economic profit.
On the contrary, if in the short run the firms are earning abnormal losses, then the existing firms will stop production and exit the market. This will lead to a decrease in the market supply, which will ultimately raise the price. The price will continue to rise until it becomes equal to the minimum of AC. ‘Price = AC’ implies that in the long run all the firms will earn zero economic profit.
Hence, when the price is equal to the minimum of AC, neither any existing firm will exit nor any new firm will enter the market.
