Final answer:
In the long run, a monopolistically competitive market will adjust through changes in marginal revenue and demand. New entrants and exits from the market will drive the market towards an equilibrium where firms earn zero economic profits, with prices and output stabilizing at a level where average cost equals demand.
Step-by-step explanation:
In a monopolistically competitive market, a long-run adjustment involves changes in marginal revenue as a result of changing demand. Monopolistically competitive firms will initially react to economic profits by expanding output and reducing prices. This is because the presence of profits attracts new entrants into the market, increasing competition. Over time, this leads firms toward a long-run equilibrium where average cost equals demand, and economic profits are eroded due to what is often referred to as 'cutthroat competition'. The market self-corrects with firms entering during profitable periods and exiting during losses.
As long as firms earn profits above the normal rate, there will be an incentive for new companies to join the market, which increases the supply and hence reduces the price. The entry of new competitors will shift the original firm's demand and marginal revenue curves to the left. This process continues until the firm's demand curve is tangent to the average cost curve indicating zero economic profits in the long run.
Conversely, if firms are experiencing losses, we will see exits from the market until the demand curve shifts rightward enough for the surviving firms to recover, eventually reaching a point where losses are eliminated and the demand curve touches the average cost curve. Both scenarios illustrate the dynamic adjustment process in such markets, aiming to achieve a state where firms earn zero economic profits in the long run, while still covering all their costs, including a normal return on investment.