In a monopolistically competitive market, firms earn zero economic profit in the long run primarily because of:

Solution

The defining characteristic of monopolistic competition is product differentiation, which gives firms some market power (like a monopoly) in the short run, allowing them to earn supernormal profits. However, the key condition for long-run equilibrium is the absence of significant barriers to entry and exit. If existing firms are making profits, it attracts new firms to enter the market. This entry increases the number of substitute products, reduces the market share and demand faced by each individual firm, and shifts its demand curve downward until it becomes tangent to the Average Total Cost (ATC) curve. At this tangency point, Price equals ATC, and economic profit is zero. Therefore, it is the process of free entry (and exit, in case of losses) that drives profits to zero in the long run.