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      Question

      In the long run, a firm operating under Monopolistic

      Competition achieves equilibrium where it earns zero economic profit (normal profit). Which of the following statements correctly describes this equilibrium state compared to Perfect Competition? 
      A The firm produces at the minimum point of its Long-Run Average Cost (LAC) curve. Correct Answer Incorrect Answer
      B The firm produces at a point where Price equals Marginal Cost Correct Answer Incorrect Answer
      C The firm produces with Excess Capacity because the LAC curve is downward sloping at the point of tangency with the Demand curve. Correct Answer Incorrect Answer
      D There are no selling costs or advertising expenditures involved in this market structure. Correct Answer Incorrect Answer
      E The demand curve facing the firm is perfectly horizontal due to the presence of many firms. Correct Answer Incorrect Answer

      Solution

      In the long run, a monopolistically competitive firm reaches equilibrium where its Demand curve (which is downward-sloping due to product differentiation) is tangent to its Long-Run Average Cost (LAC) curve. Because the demand curve has a negative slope, this tangency must occur on the downward-sloping portion of the LAC curve, to the left of its minimum point. This gap between the actual output produced and the output level that would minimize average costs is known as Excess Capacity.    Note - Because Price> Marginal cost at equilibrium, Monopolistic Competition is considered allocatively inefficient compared to Perfect Competition.

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