CFA Level I · CFA Level I Exam · The Firm and Market Structures
A firm in a monopolistically competitive market is earning positive economic profit in the short run. In the long run, the most likely outcome is that:
New firms enter, and each existing firm's demand shifts left. Economic profit attracts entrants with close substitutes because barriers to entry are low. Entry continues until demand is tangent to average total cost and economic profit is zero in the long run.
- Anew firms enter, and demand for each existing firm's product shifts leftCorrect
- Bexisting firms raise prices to protect their economic profit
- Cfirms exit, and average cost falls to the minimum point
Explanation
Low barriers to entry mean positive economic profit attracts new rivals. Their close substitute products take customers from existing firms, shifting each firm's demand curve left until economic profit falls to zero. Firms do not exit when profitable, and raising prices would lose sales.
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