5.14 Suppose that some soybean farmers experience losses over a long period and

Question

5.14 Suppose that some soybean farmers experience losses over a long period and therefore decide to exit the market. What effect will this exit have on the market supply of soybeans? How will the change in supply affect the market price of soybeans and the ability of farmers remaining in the soybean market to earn a profit?

4.5 A student makes the following comment:
I can understand why a perfectly competitive firm will not earn a profit in the long run because a perfectly competitive firm charges a price equal to marginal cost. But a monopolistically competitive firm can charge a price greater than marginal cost, so why can’t it continue to earn a profit in the long run?

How would you answer this question?

Explanation / Answer

(5.14)

As farmers exit, market supply falls. This will start increasing the market price (due to shortage), and the price rise will continue until the previous equilibrium is restored and each existing firm earns only normal profit. So, the firms staying in the industry will eventually gain once normal profits are restored.

(4.5)

Even though a monopolistic competitor maximizes profits by equating Marginal revenue (MR) with MC, it cannot earn excess profit in long run. This is because in such a market, there are many firms selling similar but slightly differentiated goods. In order to differentiate their goods from others', each firm needs to incur costs like advertising. Therefore, cost structure of each firm varies on basis of the differentiation costs incurred.

Since entry is free in long run, the short-run excess profit attracts entry in long run. Higher number of firms keep increasing market output, and individual firms' output gets lower, and firms keep lowering their price. In long run equilibrium, each existing firm's excess profit gets completely eroded and each firm produces at the lowest point of their Average total cost (ATC) curve.

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