Monopolistically competitive firms:
a. realize normal profits in the short run but losses in the long run.
b. incur persistent losses in both the short run and long run.
c. may realize either profits or losses in the short run, but realize normal profits in the long run.
d. persistently realize economic profits in both the short run and long run.
The correct answer and explanation is :
The correct answer is:
c. may realize either profits or losses in the short run, but realize normal profits in the long run.
Explanation:
Monopolistic competition refers to a market structure where many firms sell products that are similar but differentiated from each other (like fast food chains, clothing brands, etc.). In a monopolistically competitive market, each firm has some degree of market power, meaning it can influence the price of its product, but the market still has many competitors, which prevents firms from maintaining monopoly-like profits in the long run.
Short Run:
In the short run, monopolistically competitive firms can experience economic profits or losses. This is because, just like in other market structures, firms can adjust their prices and outputs to maximize profits based on their costs and demand curves. If a firm’s product is highly differentiated or if it has a temporary advantage (e.g., a new product or innovation), it might be able to earn economic profits in the short run.
On the other hand, if demand for the product decreases, or if the firm faces higher costs, it might incur economic losses in the short run. However, the key point here is that firms are not guaranteed to make profits or losses in the short run; it depends on market conditions.
Long Run:
In the long run, the situation changes because of the entry and exit of firms in the market. If firms in the market are earning economic profits, new firms will be attracted to the market by the possibility of earning profits. This entry increases competition and decreases the individual firm’s market power, leading to a decrease in price and reduction in profits. On the flip side, if firms are incurring losses, some firms will exit the market, reducing competition and allowing the remaining firms to stabilize their prices and costs.
In the long run, firms in monopolistic competition will only earn normal profits (zero economic profits). This happens because the entry of new firms drives prices down to the point where firms are just covering their costs, including a normal return on their investment.
Thus, while firms may experience profits or losses in the short run, they will break even in the long run, earning only normal profits due to the competitive forces in the market.