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The figure shows a firm which operates in a monopolistically competitive industry.
The initial demand curve faced by the firm is shown by A.R. The corresponding marginal
revenue curve is given by M.R. The firm would therefore produce output level
Q 1 as this is where profits are maximized. At this level of output, A.R. of $10 is greater
than A.C. of $6. This creates abnormal profit as shown by the shaded region.
In the long run, abnormal profits would encourage new firms to enter the industry. This would
reduce the market share of each firm and the demand curve would shift to the left. New
firms continue to enter up until the point where only normal profit is received by the
firm. This occurs where A.R. has shifted to the
left and becomes just tangential to the A.C. curve.
At the new point where profit is maximized, A.R. is equal to A.C. of $7.