Describe the transition from shortrun to longrun equilibrium

Describe the transition from short-run to long-run equilibrium in a monopolistically competitive industry.

Solution

A monopolistically competitive market is characterized by existence of many buyers and sellers with free entry in the long run.

In the short run, firms maximize profits by equating their MR with MC, and make economic profits equal to the difference in price and average total cost multiplied by equilibrium output.

In the long run, other firms are attracted by this excess profit and start entering the market. As more and more firms enter the market, an individual firm\'s demand falls more and more, so firm profit starts getting eroded. This process continues until in the long run, economic profits of all existing firms become zero and each firm earns only normal profits.