If the firms in a monopolistically competitive market are earning economic profits or losses in the short run, would you expect them to continue doing so in the long run? Why?

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If the existing firms in the market are making positive economic profits, this will lead to the entry of other firms into the same market or existing firms expanding their businesses. This shifts the demand curve faced by a monopolistically competitive firm. As more firms enter the market, the quantity demanded at a given price for any particular firm will decline, and the firm’s perceived demand curve will shift to the left. As a firm’s demand curve shifts to the left, its marginal revenue curve will also shift to the left. The shift in marginal revenue will reduce the profit-maximizing quantity that the firm chooses to produce.

The long-run equilibrium will be where the firm’s perceived demand curve touches the average cost curve, that is when the price is equal to average cost and economic profits are zero. Thus, although a monopolistically competitive firm may earn positive economic profits in the short term, the process of new entry will drive down economic profits to zero in the long run.

Similarly, if the monopolistically competitive firms are making economic losses, the firms start to exit, which will result in increased demand for each firm, and consequently lower losses. Firms exit up to the point where there are no more losses in this market.

Monopolistic competitors can make an economic profit or loss in the short run, but in the long run, entry and exit will drive these firms toward a zero economic profit outcome.