in the competitive environment economic profits are competed away because new firms are free to enter the industry and they have the information they need to compete with incumbents one of our main predictions in economics is that competition will normalize the profits across Industries so that the same resources whether they be raw materials or your talent as an entrepreneur earn roughly the same economic rewards as can be earned in any competing use let's look at how this works from the perspective of the firm firms face costs and we can represent the cost of production one unit at a time which we call marginal cost now by this point in the course I hope you feel deeply familiar with marginal costs we've seen it every which way from Flat lines to u-shaped curves but we know that no matter how it looks it represents the cost of producing the next unit average costs on the other hand tells us what the average cost per unit would be depending on how much we produced due to fixed costs that will almost always be more a more U-shaped curve in a perfectly competitive environment firms have no power over the price they earn when they sell their product they just aren't big enough they have no Market power because if they were to try to charge more some other firm is ready to jump in and take their customers and offer a better deal these firms are price takers and the price is set by the market that price sets the marginal revenue The Firm earns and a wise firm will choose to maximize their profits by producing up to the point where marginal cost is equal to marginal revenue then we can use the firm's average cost at this quantity to help us visualize their profits remember when we talk about costs we include their implicit costs or opportunity costs and so this is profit above and beyond what they require to be willing and happy to produce this product profits like this attract competition firms will enter this industry and compete the market price down pushing marginal revenue down until it meets with the point where marginal costs and average cost cross economic profits are competed away and each firm is operating at the lowest possible average cost which is a good thing then we took a look at the monopolist they too face costs but barriers to entry are preventing competition from entering when they raise their price this Market power makes them a price maker and their marginal revenue curve won't be flat but a derivative of the market demand the monopolist also chooses to produce until marginal cost is equal to marginal revenue but the price will be set by consumers willingness to pay this Market power allows the monopolist to earn high economic profits and they will be able to keep doing so until entrepreneurs figure out a way into this industry what happens if one does and a second firm enters this Market in the competitive market we saw how demand facing the firm shifted as firms entered the same thing will happen here and a competitor will split the demand with them when another firm enters the monopolist loses customers and the demand for their product Falls and becomes more elastic since consumers have other options now as a result profit shrinks what if several more firms clear the barriers to entry and start competing in this industry well then demand falls again and the oligopolis profits shrink even more this is still true if firms have Market power due to selling a unique product not available from anyone else no one else can make an iPhone but apple is not a true Monopoly they face competition from Rivals with a differentiated product that can substitute for theirs even with differentiated products firms can enter and compete so what happens if the barriers to entry are low enough that lots of firms can enter we call this monopolistic competition each firm has a differentiated product but they still face lots of competition think about the clothing industry lots of firms all compete to sell you clothes and each of them are selling something slightly different but since the barriers to entry are low and just about anyone can start their own clothing line firms in this industry don't make above normal profits they have regular accounting profits but pretty much zero economic profits everyone is earning just what they need to be willing to do it and not anymore of course there are some fashion houses which do still earn significant economic profits but don't worry we'll get to that what I'm talking about here is your friends on Facebook constantly posting about their clothing brand and trying to sell their stuff my guess is they aren't earning much money at least not any more than they could earn applying their talents to some other job when we compare perfect competition to monopolistic competition there are important similarities and differences the main difference is that imperfect competition everyone is producing an identical product it's rare that someone has a brand preference when it comes to milk or bananas or a hammer and nails or gasoline firms selling these products are generally price takers with no control over the price they earn when they sell their product and in the long run competition will drive the price to be equal to both marginal cost and average cost meaning firms are earning zero economic profits and that industry costs are minimized but in monopolistic competition firms are selling differentiated products which gives them a small amount of Market power making them price makers these firms will be able to set the price above marginal cost but competition will still drive demand down such that the price is equal to average cost another example of this would be restaurants that industry is notoriously difficult to break into because there's so much competition that your profit margins are tiny AKA you're earning accounting profit but not economic profit so in the long run just like with perfect competition economic profits are competed down to zero but unlike perfect competition because prices are set above marginal cost each firm is not operating at their minimum average cost and so the industry costs are not minimized a monopolistically competitive industry is not as efficient as a perfectly competitive industry in perfect competition the resources used are minimized but in monopolistic competition we trade some inefficiency for some product differentiation and this is often a pretty good trade we aren't getting the most we can out of our resources but we are getting a wider variety that might satisfy more people's preferences one monopolistically competitive industry is music it's pretty easy to start a band or become a singer the barriers to entry are very low especially these days when people hit big just from YouTube videos this is why almost every professional musician makes pretty normal income only a select view make it big enough to earn lots of money and usually that's because of their own Innovative approach to music over time though the best bands get copied and eventually they see their economic profits start to fall