The monopolistically competitive firm shown in the figure
Multiple Choice
is in long-run equilibrium.
can realize an economic profit.
might realize an economic profit or a loss, depending on its choice of output level.
cannot operate profitably in the short run.
The correct answer and explanation is :
To accurately provide the correct answer, we need to consider the behavior of a monopolistically competitive firm and how it operates in the short run and long run.
The Correct Answer:
Might realize an economic profit or a loss, depending on its choice of output level.
Explanation:
Monopolistically competitive markets are characterized by a large number of firms, product differentiation, and free entry and exit from the market. Here’s a breakdown of the firm’s behavior:
- Short-Run:
- In the short run, a monopolistically competitive firm can indeed earn either economic profit or incur a loss. This outcome depends on the firm’s cost structure and demand curve. If the firm’s demand curve (the average revenue curve) is above the average total cost curve at the profit-maximizing output level (where marginal revenue equals marginal cost), the firm will earn an economic profit. Conversely, if the demand curve lies below the average total cost curve at the optimal output, the firm will experience a loss.
- In the short run, the firm has some market power due to product differentiation. This allows the firm to charge a price higher than marginal cost, leading to the potential for profit or loss.
- Long-Run:
- In the long run, if firms in a monopolistically competitive market are earning economic profits, new firms will enter the market. This entry of new firms shifts the demand curves faced by existing firms to the left, reducing the price and, potentially, eliminating the economic profit.
- If firms are incurring losses in the long run, some will exit the market, which increases the demand for the remaining firms, potentially bringing them back to break-even (where price equals average total cost). Therefore, in the long run, firms in monopolistically competitive markets tend to operate at zero economic profit (normal profit), where price equals average total cost and marginal cost equals marginal revenue.
- Economic Profit in Monopolistic Competition:
- In the short run, monopolistically competitive firms have the possibility of realizing an economic profit because they can differentiate their products and set prices above marginal cost. However, this is not guaranteed, as firms may also realize a loss if their costs are too high or demand is insufficient.
In conclusion, a monopolistically competitive firm may earn a profit or a loss in the short run depending on the conditions in the market, but long-run equilibrium generally leads to zero economic profit.