Question

A student makes the following​ comment: I can understand why a perfectly competitive firm will not earn profits 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 profits in the long​ run? How would you answer this​ question?

Answer 1

Despite the fact that a monopolistically competitive firm can charge a price higher than marginal cost, in the long-run, the stiff competition, and the entry of new competitors, will shift the demand curve for the firm leftward, to a point in which the firm is obliged to lower its price to marginal cost or even lower.

For this reason, in monopolistic competition, firms should focus on product differentiation instead of price, so that demand for their demand curve does not shift leftward so much. (consumers will continue to demand their product even if its slightly more expensive because of the specific attributes that if offers).