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CSEET · Economic and Business Environment · Basics of Demand and Supply and Forms of Market Competition

In the long run, a typical firm in monopolistic competition earns only normal profit and operates with excess capacity. Which explanation is correct?

Free entry erodes abnormal profit by shifting each firm's demand curve left until it just touches average cost, so price equals average cost. Since demand slopes downward, the tangency lies before minimum average cost, leaving unused capacity. Barriers, collusion or price controls are not the cause.

  1. AFree entry shifts demand until price equals average cost, at a point to the left of minimum average costCorrect
  2. BBarriers to entry stop new firms, so price equals marginal cost at minimum average cost
  3. CFirms collude to fix output below capacity and share profits
  4. DGovernment price controls force price to equal marginal cost

Explanation

Abnormal profits attract new entrants, shifting each firm's demand curve left until it is tangent to average cost, so price equals average cost and profit is normal. Because the demand curve slopes downward, the tangency lies left of minimum average cost, meaning excess capacity. Option B describes perfect competition, not this case.

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