Short-Run Profit and Long-Run Entry

Picture that taco chain with a hit new recipe. Short run, it has a downward-sloping demand curve sitting above its average total cost curve, so it prices above cost and earns real economic profit. Other entrepreneurs see those profits and open copycat taco shops nearby. Every new entrant splits the market: the original chain's customers now have more options, so at any given price it sells less. Its demand curve shifts left. This keeps happening, profit by profit, shop by shop, as long as there is profit left to chase.

Entry stops exactly when there is nothing left to attract. That happens where the firm's demand curve has shifted left enough to become tangent to its average total cost curve: the demand curve touches ATC at exactly one point, the quantity the firm actually chooses, and price equals ATC there. Profit per unit is zero. The firm still produces where marginal revenue equals marginal cost, it just no longer makes money doing it. This is the long-run equilibrium of monopolistic competition, and it is why firms there still have market power and a downward-sloping demand curve, unlike perfect competition, but earn the same zero economic profit in the long run.

The mirror image runs in reverse. If firms are losing money, price below ATC, some exit. Exit means fewer competitors splitting the market, so each remaining firm's demand curve shifts right, raising price and shrinking losses until, again, demand is tangent to ATC and profit is zero. Entry and exit are the adjustment mechanism that connects short-run outcomes, which can be profit or loss, to a long run where only zero economic profit survives.