The diagram below shows the marginal cost (MC), average cost (AC), and demand curve faced by a representative firm in a monopolistically competitive market. Which one of the following statements is TRUE?

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BlackTom AI · Accepted Answer

Start by identifying the core idea in a monopolistically competitive market: in the long run, firms earn zero economic profit, which drives entry or exit until P = AC and the firm’s demand is tangent to its average cost curve.
Option 1: 'The market is in long run equilibrium.' While long-run equilibrium occurs, the statement is too vague here; the graph shows the firm’s demand facing downward-sloping DSR and the relationship with MC and AC. The true feature is about the shift in the demand curve faced by each firm due to entry/exit, not a blanket declaration about equilibrium status alone. 
Option 2: 'There will be fewer firms in the long run.' In monopolistic competition, firms enter when profits are positive and exit when profits are negative. Since profits are driven to zero in the long run, there isn’t a general implication that the number of firms will shrink; rather, new entrants typically increase until profits vanish. This makes this statement incorrect in this context. 
Option 3: 'In the long run, the demand curve shifts in (or left).' This matches the standard result: as new firms enter, the demand faced by an individual firm becomes more elastic and shifts left because each firm captures a smaller share of the market. The graph’s DSR line shifting left aligns with the notion of more competition and lower per-firm demand until zero profits are achieved. 
Option 4: 'In the long run, the demand curve shifts out (or right).' A rightward shift would imply each firm faces more market demand, which would typically raise profits and deter entry, contradicting the zero-profit condition in the long run for monopolistic competition. Therefore this option is inconsistent with the standard outcome. 
Collectively, evaluating all choices shows that only the leftward shift of the demand curve in the long run is consistent with monopolistic competition’s long-run equilibrium behavior, where entry erodes per-firm demand until profits are zero.

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The diagram below shows the marginal cost (MC), average cost (AC), and demand curve faced by a representative firm in a monopolistically competitive market. Which one of the following statements is TRUE?

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