If a monopolistically competitive firm is making profits

Question

Quizplus · Accepted Answer

In a monopolistically competitive market, the firm has some market power to set prices above their marginal cost, but faces competition from other firms producing similar products. If a firm is making profits, other firms are likely to enter the market due to the existence of profits. As new firms enter, the demand facing the incumbent firm decreases since consumers have more options and are no longer willing to pay as much for the incumbent firm's product. This causes a decrease in profits for the incumbent firm. Therefore, the entrance of new firms decreases the demand facing the firm, thereby reducing profits.

If a Monopolistically Competitive Firm Is Making Profits