1. Draw a graph of a monopolis
1. Draw a graph of a monopolistically competitive firm that iscurrently earning a short run profit. Be sure to include marginalrevenue, demand, marginal cost and average total cost curves. Whatwill happen to this firm as it enters the long run?
1b. What would you expect to happen to these initial firms asmore and more pubs begin branching out into other markets?
Multiple Choice/True False Questions:
1. The fact that pubs are now competing with firms likeMcDonald’s for breakfast implies that the price for a hot breakfastshould
a. RIse
b. Fall
c. Stay the same
2. The market in which pubs operate is consideredmonopolistically competitive. Which of the following is NOT acharacteristic of monopolistic competition.
A. Zero long run profit.
B. Many small firms.
C. Homogeneous product
D. Easy entry into the market.
3. As more firms enter a market, demand for the product of anyone firm will ______________ and become ________________.
A. Rise; more elastic
B. Fall; more elastic.
C. Rise; less elastic.
D. Fall; less elastic.
Answer:
(1)
A monopolistically competitive firm maximizes profit by equatingMarginal revenue (MR) and Marginal cost (MC) curves, and earnseconomic profit in short run if price is higher than average totalcost (ATC). Since entry is free in such market, short run economicprofit attracts new entry, and each firm’s profit starts to declinewith entry of more firms. The process continues until each firmproduces at a point where MR equals MC and Price equals ATC,therefore profit is zero. However, Price equals ATC to the left ofthe minimum point of ATC curve, leaving the firm with excesscapacity.
In following graph, short run is depicted in left panel and longrun is depicted at right panel. In the left panel, short runequilibrium is at point A where MR intersects MC with price P0 andoutput Q0. Since ATC lies below P0, firm is earning positiveeconomic profit equal to area P0BCD. The right panel shows long runequilibrium at point E where MR intersects MC with price P1 andoutput Q1. Since demand curve is tangent to ATC at price P1,economic profit is zero.
(1b)
(1) (a)
As more pubs (competitors in breakfast market) branches out toother market, it means that number of sellers will fall, loweringmarket supply. The market supply curve will shift leftward,increasing price and decreasing quantity.
(2) (C)
In monopolistically competitive market, each firm sells similarbut differentiated (heterogeneous) products.
(3) (B)
Entry of more firms will decrease the demand for individualfirms, and due to increased competition, firm demand curves willbecome more elastic since consumers will have more substitutesavailable.
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