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IAI Actuarial Core Principles · Business Economics · Profit maximisation under imperfect competition

A firm sells a branded product in a market with many sellers, each offering slightly differentiated products, and with no barriers to entry or exit. Which statement best describes its long-run equilibrium?

In long-run monopolistic competition, entry removes supernormal profit so price equals average cost, but the downward-sloping demand means price is above marginal cost and output is below the efficient minimum-cost scale, leaving excess capacity.

  1. APrice equals marginal cost and the firm produces at the minimum point of average cost
  2. BPrice exceeds marginal cost and the firm earns only normal profit, producing to the left of the minimum of average costCorrect
  3. CPrice exceeds marginal cost and the firm earns supernormal profit because of brand loyalty
  4. DPrice equals average cost at the minimum of average cost because demand is perfectly elastic
  5. Price is below average cost and the firm remains in the market because of its brand

Explanation

In monopolistic competition, free entry shifts each firm's demand curve until it is tangent to average cost, so supernormal profit disappears. Because the demand curve slopes down, the tangency lies left of minimum average cost, and price exceeds marginal cost. This gives excess capacity. Option A describes perfect competition.

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