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

In the long-run equilibrium of a monopolistically competitive industry, which statement is correct?

In long-run equilibrium the firm's demand curve is tangent to its average total cost curve, so it earns only normal profit. Because demand slopes downward, the tangency occurs to the left of minimum average cost, leaving excess capacity, and price remains above marginal cost.

  1. AThe firm's demand curve is tangent to its average total cost curve, so it earns only normal profit, at an output below the minimum-ATC levelCorrect
  2. BThe firm earns abnormal profit because product differentiation protects it from entry
  3. CPrice equals marginal cost and the firm produces at minimum average cost
  4. DMarginal cost exceeds price, so the firm makes a loss that persists
  5. The firm's demand curve is perfectly elastic at the market price

Explanation

Entry shifts each firm's demand curve left until it just touches ATC, so P = ATC and profit is normal. Because the demand curve slopes down, the tangency lies on the falling part of ATC, so output is below the efficient scale and there is excess capacity. P exceeds MC at the MR = MC output.

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