Monopolistic Competition _Monopolistic competition is an appropriate name for this important market structure. There is competition because there isa large number of firms producing similar but not identical products. Each firm has some monopoly power over price because its product is different from others with which itis competing, Each monopolistically competitive firm faces a downward sloping demand (D) curve so it has to reduce its price to have consumers buy more of its product. This means it has a downward sloping marginal revenue (MR) curve that lies below its D curve. In fact, the revenue graph of a monopolistically competitive firm looks like the revenue graph of a monopoly. A monopolistically competitive firm is similar to a perfectly competitive firm because while it can earn a positive total profit in its short-run equilibrium, it will break even in its long-run equilibrium. Iti different from a monopoly in this regard because a monopoly can maintain a positive total profit in the long run as Jong as it has barriers to entry that prevent other firms from coming into the market. Part A: Short-Run Equilibrium of a Monopolistically Competitive Firm A monopolistically competitive firm is in short-run equilibrium when it produces the output where ‘marginal revenue equals marginal cost (MR = MC). Its optimal price is found on its demand curve at this output level. Like other firms, the firm will shut down if at its best output level, its total revenue is less than its total variable cost. Figure 3-16.1 shows a monopolistically competitive firm in short-run equilibrium with an output of 600 units per period. Answer the questions that follow the graph. a Figure 3-16.1 A Monopolistically Competitive Firm in Short-Run Equilibrium K $130) REVENUE, COST a3 QUANTITY -Aéencd cee Economie MicoconomiceSsdent scr Manl © Counc for Banal Eatin, New York NY. 2011, What price will the firm charge for its profit-maximizing output? 2. What are the dollar values and coordinates of these items atthe output of 600 units? (A) Total revenue (B) Total cost (C) Total profit (D) Average profit (E) Marginal profit 3. What is the value of the firm’s total fixed cost at 600 units? What is the value of its total fixed cost at O units? 4 Should this firm shut down? Why? 5: On the horizontal axis, indicate by Q, the output level society would lke this firm to produce. ‘Why does the firm not want to produce Q,? & On the horizontal axis, indicate by Q, the output level at which this firm would maximize its total revenue. Why does the firm not want to produce Q,? 7. What are the dollar value and the coordinates of consumer surplus when the firm maximizes its total profit? 202 ‘dred Pcement conics Miroonamic: Sider Rene Nana © Cova fo econ aon, New Yo NEPart B: Movement from Short-Run Equilibrium to Long-Run Equilibrium, If firms in a monopolistically competitive market are earning positive economic profits, other firms have an incentive to enter this market. As they do so, each firm's share of the total market demand gets smaller and smaller, This means the demand curve facing a monopolistically competitive firm shifts to the left. This process continues until ll firms remaining in the industry break even. Outside firms then will no longer have an incentive to enter the market, and existing firms will have no reason to leave because they are receiving their normal profit. Figure 3-16.2 shows the demand and average total cost ‘curves for a typical firm in the monopolistically competitive market for sport shirts. a Figure 3-16.2 ‘Movement of a Monopolistically Competitive Firm to Long-Run Equilibrium ATC PRICE 6 (QUANTITY 8, Ifthe demand curve for this firm is D,, is the firm earning positive total profit? If so, will other firms enter the market? What will this do to this firm’s share of the market demand? 9. If this firm's demand decreases from D, to D, will the firm earn a positive total profit? What will happen to this firm’s share of the market demand? ‘Adwaced Pacenent Economies Mzoeconomice Student Resor Mana © Coc fr Economie Eaton, New York NX 20310. Assume the demand facing the firm drops from D, to D,, Will it earn a positive total profi? If some other firms in the industry are in a similar situation, what will happen to the number of firms in the industry? What will happen to this firm’s share of the market demand? N. Suppose this firm's demand shifts from D, to D,. Is this firm making a postive total profit ora Joss? If this is the condition for other firms as wel, will firms enter or leave the market2 Part C: Evaluation of a Monopolistically Competitive Firm in Long-Run Equilibrium When a monopolistically competitive firm isin long-run equilibrium, it wll break even or earn $0 in ‘otal economic profit. Because itis receiving its normal profit, it is doing as well with its resources here 3s it would in its best alternative. Thus, the firm has no incentive to leave the industry. Figure 316.3 ilustrates a monopolistically competitive firm in long-run equilibrium with quantity Q* and price P* a Figure 3-163 A Monopolistically Competitive Firm in Long-Run Equilibrium AVC REVENUE, COST 3 a quantity M IR 204 Ataeed Pct Econo Microeconomics Student Rewurce Mal © Coun fr Ean Bcaon NewYork12. If you were asked to draw a graph of a monopolistically competitive firm in a position of long-run equilibrium, there are two conditions you must show with your graph at the profit-maximizing output, (A) At Q*; the firm’s average revenue (or price) must be (greater than / equal to / less than) its average total cost. This is shown by drawing the demand curve tangent to the ATC curve at point A. (B) AtQ%, the firm’s marginal revenue must be (greater than / equal to / less than) its marginal cost. This is shown by drawing your MR curve through the MC curve at Q* at point B. 13, Is a monopolistically competitive firm productively efficient when itis in long-run equilibrium? Explain. 14, Is a monopolistically competitive firm allocative efficient when itis in long-run equilibrium? Explain, 15, Is the demand curve facing a monopolistically competitive firm more or less elastic than the demand curve facing a monopoly? Why? 16, What are the characteristics of a monopolistically competitive market? What are two examples of such a market? ‘danced Pere! Economics Miozonomice Sent Recarce Mana © Counc for Rano Edun, New York, 205