Question

1. Draw and label a graph depicting a monopolistic market from the perspective of a single firm. Make sure you illustrate the profit maximizing price and quantity .

   1. Start with a graph depicting market equilibrium for the monopolistic market .

   2. Modify the graph to demonstrate that the price at the profit maximizing level of output is below the average variable cost curve .

   3. Discuss the following characteristics of a the firm depicted in part 1 :

   4. Is the firm making a profit or loss? Show this area on the graph in part 1.

   5. Will the firm decide to continue to produce in the short-run (will it shutdown)?
   6. Will the firm decide to continue to produce in the long-run (or will it leave the market) ?

Answer 1

Ans) Monopolistic market is where there are many sellers selling homogeneous but differentiated products. There is no or very less barrier to entry and exit. A profit maximising firm produces the quantity where MR and MC curve intersect and then uses demand curve to determine the price.

If price is above ATC, firms earn positive economic profit. If price is equal to ATC, firms earn zero economic profit. If price is below ATC, firms earn negative economic profit.

When price is below ATC, firms will see whether the price is above or below AVC. If price is above AVC, firm will continue to produce in short run and will leave the market in long run if conditions do not get better. But if price is below AVC, firm will shutdown in short run and will leave the market in long run if conditions do not get better.

D AR

shutdown MC AVC D nr