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Q: Everyone says you need to have a character arc, but they don't say how to do it. What exactly is a character arc?

Character Arc: the rocky path of personal growth and development a character undergoes in a story, usually unwillingly, during which the character wrestles with and eventually overcomes some or all of a serious emotional fear, limitation, block or wound. In other words, he's a reluctant hero. He'll have to force himself to change whatever flaw you've blessed him with, and whatever roadblocks you've thrown out to stop him--but he does. He does because the stakes are too high for him not to.   The purpose of each of these roadblocks are to raise the tension. To make the readers wonder if he can do it and to keep them turning the pages. He doesn't have to be loved by the readers, but he does have to have their empathy or they won't be hooked.

Think of an alcoholic whose family left him. He knows they won't be back unless he stops drinking, but he finds it too difficult to stop. His job, his friends, everything he does seem to conspire to keep him where he is. He's weak. He becomes homeless. Can he talk himself into changing? Conflict, tension, empathy. If he remains the same at the end, there is no arc in the character or the plot and the story won't be interesting. If he succeeds easily, there is no arc and it still won't be interesting. But now it won't be believable either. Changing is hard!
Here’s a great example of a character arc: Tom Cruise’s character in "Rain Man."

Beginning – Cruise is a ruthless car dealer who kidnaps his autistic brother because he feels cheated about not receiving any money from his father's will.
End of Arc – After a cross-country journey with his brother, he learns the importance of family and turns down the money.
The conflict of his flaw is subtly interwoven throughout the story, moving the story forward.

Character arc is absolutely fundamental to story success. It’s not only how the character learns and grows and changes (arcs) as a result of their experiences within the story, but how they apply that learning in bringing about the conclusion of the story.  Much of the arc is in the background, in the thoughts of the main character. However, the other characters see the change in his actions and dialogue.