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Question
What is the reason for the long run equilibrium of a firm in monopolistic competition to be associated with zero profit?
Solution
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.
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RELATED QUESTIONS
A monopoly firm has a total fixed cost of Rs 100 and has the following demand schedule:
|
Quantity |
1 |
2 |
3 |
4 |
5 |
6 |
7 |
8 |
9 |
10 |
|
Price |
100 |
90 |
80 |
70 |
60 |
50 |
40 |
30 |
20 |
10 |
Findthe short run equilibrium quantity, price and total profit. What would be the equilibrium in the long run? In case the total cost is Rs 1000, describe the equilibrium in the short run and in the long run.
If the monopolist firm of Exercise 3, was a public sector firm. The government set a rule for its manager to accept the government fixed price as given (i.e. to be a price taker and therefore behave as a firm in a perfectly competitive market). And the government decide to set the price so that demand and supply in the market are equal. What would be the equilibrium price, quantity and profit in this case?
The market demand curve for a commodity and the total cost for a monopoly firm producing the commodity is given in the schedules below.
|
Quantity |
0 |
1 |
2 |
3 |
4 |
5 |
6 |
7 |
8 |
|
Price |
52 |
44 |
37 |
3 |
26 |
22 |
19 |
16 |
13 |
|
Quantity |
0 |
1 |
2 |
3 |
4 |
5 |
6 |
7 |
8 |
|
Total Cost |
10 |
60 |
90 |
100 |
102 |
105 |
109 |
115 |
125 |
Use the information given to calculate the following:
(a) The MR and MC schedules
(b) The quantities for which MR and MC are equal
(c) The equilibrium quantity of output and the equilibrium price of the commodity
(d) The total revenue, total cost and total profit in the equilibrium
Will the monopolist firm continue to produce in the short run if a loss is incurred at the best short run level of output?
Explain why the demand curve facing a firm under monopolistic competition is negatively sloped.
