Question

a. Draw a pair of diagram illustrating both Short-run and Long Run equilibrium of Chamberlinian monopolistic competition. The diagrams contain average cost, average variable cost, marginal cost, and marginal revenue curves and shade area that represents abnormal profit. Make your diagrams large and label all curves, axes, and points.

b. In the price-leadership-by-a-dominant-firm model: a. After the dominant firm sets the market price, what is the output-supply behavior of the remaining firms in the industry?

Answer 1

a) Short run profit=(price-ATC)*quantity. In the short run, a monopolistically competitive firm produces quantity at MR=MC. If the average total cost is below the market price then the firm will earn an economic profit.

In the long run, more firms enter because of this profit which reduces the profit of other firms. Firms will enter until the firms earn only a normal profit. Firms earn a normal profit when P=ATC. That is the demand curve tangent with the average total cost.

Excess capacity is (the quantity produced at minimum ATC-quantity that earns the greatest profit at MR=MC). Monopolistically competitive firms do not operate at their minimum ATC so operate with excess capacity.