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I read that companies in the monopolistic competition make zero economic profit in the long term. Why would a company do that when it can maximize the profit instead?

My reasoning is that the former company will have less selling price which will draw all the customers of the profit-maximizing company.

If my reasoning is correct, how does Apple and Microsoft have a net profit margin of 25% and 37% (respectively) and not close to 0%? If we look at other large companies like Walmart and Amazon, they are monopolistic and yet have a profit margin of around 2%.

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    $\begingroup$ Something to keep in mind is that many companies with small profit margins have large total profits. $\endgroup$
    – Mark
    Aug 6 at 2:29

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I read that companies in the monopolistic competition make zero economic profit in the long term. Why would a company do that when it can maximize the profit instead?

Please give sources when you write something like "I read"!

In the (theoretical) monopolistic competition model companies do make zero economic profit in the long term, because competitors keep entering the market while it is profitable to do so, and the market share of each company dwindles until revenues are just enough to cover costs. In this model the companies do maximize their profits, but in the long-run competition is so tough the best they can do is break even (reach zero profit).

My reasoning is that the former company will have less selling price which will draw all the customers of the profit-maximizing company.

As pointed out above, in this model all companies maximize profit, that is their objective. As a result, they don't even want to draw away customers at a lower price if that means a loss for them! P.s.: Unlike in the (theoretical) model of Bertrand competition, having a slightly lower price will not attract all of a competitor's customers, just some.

If my reasoning is correct, how does Apple and Microsoft have a net profit margin of 25% and 37% (respectively) and not close to 0%?

Well, I would argue that the monopolistic competition model is a toy model and there is no reason to think that it fits this real-life situation. Both of these companies derive a lot of revenue from platforms, where the economic dynamics are different and do not necessarily favor a division of the market among small competitors. One could also argue that not all the markets these companies are in have reached their long-run equilibrium.

If we look at other large companies like Walmart and Amazon, they are monopolistic and yet have a profit margin of around 2%.

I did not know that Walmart only has a profit margin of 2%! That is surprising to me, could you please provide a reference? As for Amazon, it is heavily growth oriented and reinvests a lot of the money they make. Also, international tech companies can do some creative accounting, so their profit margins are hard to estimate.

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    $\begingroup$ You can find the Walmart info here. $\endgroup$
    – Isa Pérez
    Aug 4 at 7:37
  • $\begingroup$ Overall, I understand it. Thank you for the answer. $\endgroup$
    – Isa Pérez
    Aug 4 at 7:38
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    $\begingroup$ Profit margins on staples and groceries are quite often low, because a large portion of the market is highly price-sensitive, so the dominant strategy is to charge low prices, go all-in on economies of scale, and make it up in volume. You may have a low margin, but you'll still have high absolute profits because you have sky high volume. $\endgroup$
    – Kevin
    Aug 5 at 19:07
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Why companies choose to make zero economic profits in the long-term when it can maximize it instead?

Companies do not choose to make zero economic profits. In economics we start with assumption that companies want to maximize profits.

However, profit maximization in some market structures such as perfect competition or monopolistic competition leads to zero economic profit (see Mankiw Principles of Economics).

This is because in these market structures entry is free and competition is so cutthroat that best that profit maximizing firm can do is to have zero profit.

Why does Apple have large profit margins?

First, of all Apple is clearly not company operating under perfect competition, and one could argue it is not operating under monopolistic competition either since in the market for high end luxury phones there are only few competitions, and there might be implicit entry barriers so it could be argued oligopoly model is better fit for Apple.

In oligopoly entry barriers and less competition allows profit maximizing companies to get some economic profit.

However, this being said you seem to be confusing economic and accounting profit.

Accounting profit is what you find on profit and loss (income) statement of Apple. That is however not the real economic profit of a company. The economic profit is calculated by also subtracting opportunity cost that the company has.

For example, if Apple invests into its business 1 million USD to buy capital, and then they get 100000 USD profit, but the same 1 million USD could be invested into mutual fund with 10% return (yielding 100000USD), the economic profit of Apple would be zero.

The point is that accounting profit margins provide zero indication of how profitable the company is in economic terms.

This being said I am pretty sure that company such as Apple has lot of market power so they have genuine economic profit. However, even with (accounting) profit margin of 27% or even orders of magnitude higher you can’t just automatically say company actually earns economic profit. Company could have economic loss or just 0 economic profit even with large (accounting) profit margin. Whether company has economic profit or not has to be estimated by trying to estimate all implicit costs that accounting ignores, and also correcting for some things that are done in accounting for sake of simplicity (eg straight line depreciation) that do not reflect actual economic reality. In addition you would ideally correct for all shenanigans companies do to under or overreport their figures in accounting.

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  • $\begingroup$ Thanks for taking the time to explain it. Can you give me an example of a near-perfect (as theoretical perfectness may not be achievable in reality) monopolistic competition? $\endgroup$
    – Isa Pérez
    Aug 5 at 6:05
  • $\begingroup$ @IsaPérez branded but not exclusive high end clothing $\endgroup$
    – 1muflon1
    Aug 5 at 9:00
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I am going to challenge your assumption that the companies aren't making a profit.

Companies pay taxes based off of NIBT (net income before taxes). If your company has a net income of $0 dollars after all your expenses have been added up then your company doesn't pay income tax. (which ranges from 20% to 37%).

A prudent businessman doesn't like the idea of paying taxes, so will try to avoid it. This includes offloading IP (intellectual property) to offshore companies based in places like Ireland or the Bahamas (countries with extremely low income taxes). The offshore companies take royalties for the intellectual property the main company is doing and suddenly your 20% profit margin becomes a deficit that needs a government bailout (because you are too big to fail, and your failure will cause 'incalculable economic damage'). So you avoid taxes large social network platform and get the government to give you money to keep your 'struggling' business afloat, unnamed large car manufacturer, unnamed big bank...

How it is actually done is a lot more complicated than I have described.

Large corporations that report a net zero profit margin often have a zero profit margin because they have moved their profits outside of the USA thru creative accounting. Not because they aren't making money... Businesses that don't make money go out of buisness.

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    $\begingroup$ "I am going to challenge your assumption that the companies aren't making a profit." The OP is not making this assumption, all the profit rates they quote are positive? $\endgroup$
    – Giskard
    Aug 4 at 19:50
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    $\begingroup$ "Businesses that don't make money go out of buisness." What about Uber? $\endgroup$
    – Giskard
    Aug 4 at 19:50

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