Most of the service-based businesses in your neighbourhood, such as hair
salons, exist in monopolistically competitive markets.
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To see why this “tangency solution” provides the only possible long-run
equilibrium for an industry that fulfills all of the theory’s assumptions,
consider the two possible alternatives. First, suppose the demand curve
for each firm lies below and never touches its LRAC curve. There would
then be no output at which costs could be covered, and firms would leave
the industry. With fewer firms to share the industry’s demand, the
demand curve for each remaining firm shifts to the right. Exit will
continue until the demand curve for each remaining firm touches and is
tangent to its LRAC curve. Second, suppose the demand curve for each
firm cuts its LRAC curve. There would then be a range of output over
which positive profits could be earned. Such profits would lead firms to
enter the industry, and this entry would shift the demand curve for each
existing firm to the left until it is just tangent to the LRAC curve, where
each firm earns zero profit.