Explain why monopolistically competitive firms usually earn zero economic profit in the long run but oligopoly firms usually earn positive profits in the long run.
Monopolistic competition (long run):
Structure: Many firms, differentiated products, and free entry and exit.
Short run: Firms can earn positive economic profits because product differentiation gives each firm some market power (downward-sloping demand).
Entry effect: Positive profits attract new entrants offering close substitutes. As new firms enter, the demand for each incumbent’s product shifts left and becomes more elastic.
Long-run equilibrium: Entry continues until economic profits are driven to zero. At that point price equals average total cost (P = ATC), though P still exceeds marginal cost (P > MC), implying excess capacity and markup but no economic profit.
Oligopoly (long run):
Structure: A few large firms, strategic interdependence, and typically significant barriers to entry (e.g., economies of scale, control of key inputs, patents, high startup costs, or strong brand loyalty).
Barriers to entry: These barriers prevent easy entry by new firms, so incumbent firms do not face continual downward shifts in demand caused by entry.
Strategic behavior: Firms may sustain prices and quantities through tacit or explicit collusion, price leadership, or strategic pricing that keeps profits above competitive levels.
Long-run outcome: Because entry is limited and firms can coordinate or strategically maintain market power, oligopolistic firms commonly earn sustained positive economic profits in the long run.
Summary:
The key difference is entry. In monopolistic competition, free entry erodes economic profits until they are zero. In oligopoly, barriers to entry and strategic interactions among a few firms allow supra-normal profits to persist.
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