Chapter 10.1: Monopolistic Competition

Question 1

Conditions of a monopolistically competitive firm

Answer 1

• Large number of firms
• Control over price
• Low barriers to entry
• Similar but differentiated products
• Non-price competition (advertising)

Question 2

How do firms differentiate their products (non-price competition)?

Answer 2

• Physical aspects.
• Location in which its sold.
• Intangible aspects (reputation, free delivery etc.).
• Perceptions of the product thru advertisements.

Question 3

Compare perceived demand of monopoly and monopolistic competition

See fig. 10.1

Answer 3

Monopoly: perceived demand is market demand; inelastic.
Monopolistic competition: perceived demand is based on extent of product differentation and how many competitors it faces; elastic.

Question 4

Compare monopoly and monopolistic competition

Answer 4

Monopoly: high barriers of entry, no competition or close substitutes.
Monopolistic competition: faces competitors , low barriers of entry, and has subs.

Question 5

How does a monopolistic competitor choose its profit-maximizing Q and P?

Answer 5

1. Produce at Q where MR = MC.
2. Decide price by drawing a line from profit-maximizing quantity to demand.
3. Calculate TR, TC, and profit.

Question 6

Draw and explain long-run adjustment when firm experiences above-normal profits

See fig. 10.3 a)

Answer 6

1. Firm is experiencing positive economic profit (P > ATC when its hit demand curve). This will attract competition.
2. Another competitor enters market → this firm’s perceived demand shifts left (new firms steal existing firms’ customers) and associated MR curve also shifts left. This leads to a new (lower) profit-maximizing quantity (MR = MC).
3. Firm earns 0 econ. profit (produces at MC = MR where it hits ATC).

Question 7

Does Monopolistic Competition fulfill productive and allocative efficiency in the long-run?

Explain using fig. 10.3

Answer 7

Result of entry and exit:
* firms end up with a price that lies on the downward-sloping portion of ATC curve . . . Productive efficiency (P = min. ATC) is not fulfilled.
* Allocative efficiency (P = MC) is not fulfilled because firms produce at quantity where P > MR = MC.

Question 8

Why do monopolistically competitive firms engage in non-price competition?

Answer 8

Bc firms face relatively elastic demand, so they engage in product differentiation (non-price competition) in order to sustain in the market. The goal is to innovate their products to appeal to consumers.