LOS b: Determine the profit-maximizing (loss-minimizing) output under monopolistic competition, explain why long-run economic profit under monopolistic competition is zero, and determine if monopolistic competition is efficient.

In a market characterized by monopolistic competition, companies can earn positive economic profits in the short run if the price of their product is greater than the average total cost of producing it. In the long run, because barriers to entry are low, economic profits will attract new entrants. Additional producers will drive the price lower until price equals average total cost, economic profit is zero, and new competitors no longer have an incentive to enter the market.

New firms will enter a monopolistic competitive market with economic profits above zero and will absorb some market demand. This will shift the demand curve down to the point where price equals average total cost and there are zero economic profits.

Price searchers maximize profits by producing an amount of output where MR equals MC and charging a price based on the demand curve. In the short run, profits or losses occur depending upon where the individual firm’s ATC curve is in relationship to the demand curve. In the long run, economic profits are zero due to the low barriers to entry. Important note for the test: regardless of whether a firm is a price taker, price searcher, monopoly, or oligopoly, all firms will seek to maximize profits and want to produce the ouput where marginal revenue equals marginal cost.