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Difficulty: EasyMonopolistic Competition: Features, Product Differentiation, and Equilibrium

In a monopolistically competitive market, which feature ensures that firms earn only normal profit in the long run?

  1. A
    High structural barriers preventing new sellers from entering the industry
  2. B
    Marginal revenue being equal to market price at all output levels
  3. Freedom of entry into and exit from the industryAnswer
  4. D
    Price rigidity caused by rival firm interdependence on a kinked demand curve

Answer

Freedom of entry into and exit from the industry ensures that monopolistically competitive firms earn only normal profits in the long run.
In monopolistic competition, the absence of major entry barriers allows new firms to enter the market whenever existing firms earn short-run supernormal profits. The arrival of new firms introducing close substitute products reduces demand for each individual firm's product until average revenue equals average total cost, leaving sellers with only normal profit in the long run.

Step-by-Step Solution

1
Identify short-run profits and market entry conditions
In the short run, firms can earn supernormal (economic) profit. Because barriers to entry are low, these profits attract new sellers into the industry.
Understanding how incentives drive market dynamics.
2
Determine the impact of entry on firm demand and long-run profits
As new substitute products enter the market, the demand curve facing each individual firm shifts leftward until demand is tangent to average total cost (P=ATCP = ATC), resulting in normal profit.
Free entry increases available substitutes and divides market demand among more sellers.

Key Concept

Long-run equilibrium and free entry in monopolistic competition
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Topics

Monopolistic Competition: Features, Product Differentiation, and Equilibrium

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