Question

Now that you have studied monopolistic competition, let's see how well you can distinguish a firm in a monopolistically competitive market from a firm in a perfectly competitive market. Given the description of the firm below, decide whether it applies to monopolistic competition, perfect competition, or both. You may have to adjust the scroll bar to see the complete list.

Items (9 items) (Drag and drop into the appropriate area below)

• a firm that may earn an economic profit or loss in the short run

• a firm that produces an identical product to all of its rivals

• a firm that produces at efficient scale in the long run

• a firm that earns zero economic profit in the long run

• a firm that maximizes profits by producing where MR = MC

• a firm that has market power

• a firm that sets price greater than marginal cost

• a firm that faces a downward-sloping demand curve

• a firm that produces with excess capacity in the long run

Categories

• Perfect competition




• Monopolistic comp.




• Both

Answer 1

Answer 2

1)A firm that produces at efficient level in the long run.

Answer - perfect competition.

A perfectly competitive firm in the long run produces at the efficient level of output. In the long run, the firm produces that level of output where average total cost is minimum.

Monopolistic competition is Incorrect because a firm in monopolistic competition produces that level of output where average total cost is not minimum. If it produces that level of output then production has to be increased, and to sell additional units of output, price has to be reduced. As such , marginal revenue falls. Hence, the firm stops producing where marginal cost is equal to marginal revenue and does not increase production where ATC is minimum.

2) A firm that produces an identical product to all its rivals.

Answer- perfect competition.

Perfect competition is a market structure in which there are a large number of sellers producing a homogeneous product. The product sold by a perfectly competitive firm is exactly the same i.e., identical of it's rivals. They are close substitutes of each other.

Monopolistic competition is Incorrect because monopolistic competition is a market structure in which there are a large number of sellers of a particular product, each seller selling somewhat differentiated product sold by other sellers. The product sold in monopolistic competition is not identical, but somewhat differentiated.

3) A firm that produces with excess capacity in the long run.

answer- monopolistic competition

A monopolistically competitive firm faces a downward sloping demand curve indicating that price need to be reduced to sell additional units of output. A monopolistically competitive firm does not produce at the efficient level where average total cost is minimum. If it does so, then production has to be increased and to sell additional units of output, price need to be reduced. As such marginal revenue will fall. Hence, it produces at a level which is less than efficient level and hence generates an excess capacity in the long run.

Perfect competition is Incorrect because a perfectly competitive firm in the long run produces at that level of output where average total cost is minimum i.e., at the efficient scale and hence no excess capacity is generated.

4) A firm that has market power.

answer- monopolistic competition.

A monopolistically competitive market consists of a large number of firms selling somewhat differentiated product. But, the number of sellers is not too large to not be able to influence the price of the product. Each firm sells somewhat differentiated product from it's competitors and has considerable market share so as to influence the price of the product. Hence, monopolistic competition has some market power as firms in it can set the price of it's product .

Perfect competition is Incorrect because the number of sellers in perfect competition is so large that each firm produces such a small share of total market supply that it is unable to influence the price of the product. It has no market power.

5) a firm that sets price greater than marginal cost.

answer- monopolistic competition.

A monopolistic competitive firm has considerable market power to set the price of it's product. It faces a downward sloping demand curve indicating that price has to be reduced to sell additional units of output. As price reduces, marginal revenue also falls and is always less than price. The firm produces that level of output where marginal cost is equal to marginal revenue. As price is always more than marginal revenue,and marginal cost is equal to marginal revenue (at the profit maximising output) the price is always more than marginal cost.

Perfect competition is Incorrect because in perfect competition, price is not reduced to sell additional units of output. As all the units of output are sold at the same price, marginal revenue earned from the sale of an additional unit of output is same as that of price. The firm produces that level of output where marginal cost is equal to marginal revenue. As price is equal to marginal revenue, price charged is also equal to marginal cost. Hence, the perfectly competitive firm does not charge a price greater than marginal cost.

6) A firm that earns zero economic profits in the long run.

answer-both, perfect competition and monopolistic competition.

Both perfect competition and monopolistic competition are characterised by free entry and exit. Free entry and exit ensures that all the firms in the long run earn normal profits only i.e., just covering their costs ( zero economic profits) . If existing firms are earning economic profits , new firms will enter the industry which will wipe out all the profits and all firms earn normal profits only ( zero economic profits). If existing firms are incurring losses, firms would exit the industry in the long run, which will eliminate all the losses and firms earn normal profits only ( zero economic profits).

7) A firm that maximizes profits by producing where MC= MR.

answer- both, perfect competition and monopolistic competition.

Both perfectly competitive firm and monopolistically competitive firm produces that level of output where marginal cost is equal to marginal revenue (MC=MR). This is the profit maximising output for both perfectly competitive firm and monopolistically competitive firm.