When a monopolistically competitive firm is in long-run equilibrium, Select one: a. price is equal to average total cost. b. price is equal to marginal cost. c. price is equal to marginal revenue. d. the firm operates at its efficient scale.
The Correct Answer and Explanation is :
The correct answer is: a. price is equal to average total cost.
Explanation:
In a monopolistically competitive market, firms face competition from other firms producing similar but not identical products. The characteristics of monopolistic competition include many firms, product differentiation, and free entry and exit from the market in the long run. In the short run, firms can make profits or losses, but in the long run, the entry and exit of firms ensure that economic profits are zero.
Here’s a breakdown of why the correct answer is a. price is equal to average total cost:
- Long-Run Equilibrium:
In the long run, the process of entry and exit of firms into the market causes the economic profit of each firm to be driven to zero. If firms in the market are making economic profits, new firms will enter the market, increasing competition and reducing the price, which lowers the profits of existing firms. Conversely, if firms are making losses, some will exit the market, reducing competition and raising the price, which will eliminate losses. - Price Equals Average Total Cost:
In long-run equilibrium, the firm will adjust its production such that the price of its product equals its average total cost (ATC). This condition reflects zero economic profit because, in monopolistic competition, firms cannot sustain long-term profits due to the ability of other firms to enter the market and offer similar products. - Why Not the Other Options?:
- b. Price equals marginal cost: In monopolistic competition, the price is generally greater than marginal cost in the long run, unlike perfect competition where price equals marginal cost.
- c. Price equals marginal revenue: In monopolistic competition, the price is greater than marginal revenue, as firms face a downward-sloping demand curve.
- d. The firm operates at its efficient scale: In monopolistic competition, firms do not operate at their efficient scale (where average total cost is minimized). Due to product differentiation, firms usually operate with excess capacity.
Thus, price equals average total cost in the long run when a monopolistically competitive firm is in equilibrium.