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In the absence of substantial economies of scale, it is possible for additional firms to enter the market, driving down prices and profit.
Output decisions are based on the marginal principle:
Marginal PRINCIPLEIncrease the level of an activity if its marginal benefit exceeds its marginal cost, but reduce the level if the marginal cost exceeds the marginal benefit. If possible, pick the level at which the marginal benefit equals the marginal cost.
Short-run and Long-run Equilibrium Under Monopolistic Competition
As firms enter, each firm’s demand curve shifts to the left, decreasing market price, decreasing the quantity produced per firm, and increasing the average cost of production.
As long as there is profit to be made, more and more firms will enter the market.
Entry will stop once the economic profit of each existing firm reaches zero. In the long run, revenue will be just enough to cover all costs, including the opportunity cost of all inputs, but not enough to cause additional firms to enter.
Long-run Equilibrium Under Monopolistic Competition
In this example, the marginal principle is satisfied at 55 thousand toothbrushes per minute, selling at a price of $1.35. The cost of producing each toothbrush is also $1.35. Economic profit equals zero.
There are many spatially differentiated products. When firms differentiate their products by offering them at more locations, the benefit of having more firms is that consumers travel shorter distances to get the product.
With a single seller, the average cost of production would be lower, but prices would be higher, and consumers would spend more time traveling to buy the product.