Question

(a) Table-2 below shows the demand and the cost data facing 'Velvet Touches', a monopolistically competitive producer of velvet throw pillows. Table 2 TR $ MR$ MC $ Profit $ Quantity Price $ TC$ 32 1 30 30 2 28 56 43 26 78 53 4 24 96 64 76 22 110 6 20 120 90 7 18 126 106 16 126 128 Calculate MR and MC and complete the columns. (1.5 marks) (i) (ii) What are the profit maximising quantity and price for 'Velvet Touches'? (1 mark) (iii How much is the profit or loss of the firm? Show the working. (1 mark) If the firm's profit or loss is typical of all firms in the market for throw pillows what is likely to happen in the future? (1 mark) (iv) (v) Will there be more firms, or will some existing firms leave the industry? Explain your answer. (1 mark) (vi) What will happen to a typical firm's profit or loss after all entry/exit adjustments? (0.5 mark)

Answer 1

Quantity	Price	TR	MR	TC	MC	Profit
1	30	30	-	32	-	-2
2	28	56	26	43	11	13
3	26	78	22	53	10	25
4	24	96	18	64	11	32
5	22	110	14	76	12	34
6	20	120	10	90	14	30
7	18	126	6	106	16	20
8	16	128	2	126	20	2

ii) When the quantity of Velvet touches produced is 5 and the price level is 22$ the profit is the maximum at 34$. Hence is the profit-maximizing price and quantity.

Or

Since this is a monopolistic competitive firm the profit-maximizing condition is MR=MC but here at none of the quantities, we are getting a quantity where MR=MC.

iii) the total revenue of the firm is TR = (30+56+78+96+110+120+126+128) = 744

TC = (32+43+53+64+76+90+106+126) = 590

Hence Profit = TR-TC = 744-590 = 154$

iv) If one monopolistic competitor earns positive economic profits which is 154$, other firms will be tempted to enter the market. This will shift the demand curve faced by the firm As more firms enter the market, the quantity demanded at a given price for any particular firm will decline, and the firm’s perceived demand curve will shift to the left. As a firm’s perceived demand curve shifts to the left, its marginal revenue curve will shift to the left, too. The shift in marginal revenue will change the profit-maximizing quantity that the firm chooses to produce since marginal revenue will then equal marginal cost at a lower quantity.

v) Since there is positive economic profit hence other firms will be lured to this industry and they would enter the market rather than leave the industry. This will gradually bring down the profit to normal and the supply of quantities produced will also increase.