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CA Foundation · Business Economics · Price Determination in Different Markets

In the short run, a monopolistically competitive firm is earning supernormal profits. What is the most likely long-run consequence?

New firms will enter because entry is free and profits are attractive. Their close substitutes take away customers, shifting each existing firm's demand curve leftward until price equals average cost and only normal profit is earned. Exit happens under losses, not supernormal profits.

  1. ANew firms enter, shifting the demand curve of existing firms to the left until profit is normalCorrect
  2. BExisting firms exit, shifting the demand curve of remaining firms to the right
  3. CThe firm's demand curve becomes perfectly elastic at the market price
  4. DThe firm becomes a monopolist as rivals cannot imitate its product

Explanation

Entry is free under monopolistic competition, so supernormal profits attract new firms offering close substitutes. Each existing firm loses some share, so its demand curve shifts left until price equals average cost and only normal profit remains. Exit would occur under losses, not profits.

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