Question

12. (15 points) a. Draw a diagram to show a profit maximizing monopolistically competitive firm in a long run equilibrium, and fully explain your diagram. This requires use of cost curves plus demand and related curves. b. Explain what aspect of the market structure gives the firm "monopoly" power, and discuss how this is represented in the diagram. c. What aspect of the market structure makes the firm "competitive". How is this represented in the diagram?

Answer 1

Equilibrium of firm under monopolistic competition: The firm under monopolistic competition will have a downward sloping demand curve(Average revenue curve ) because of PRODUCT DIFFERENTIATION. The corresponding marginal revenue curve will be below the AR curve, as shown in Diagram.In the short run, profits competing in monopolistic competition, can be at any level.Unlike monopoly , there are no barriers to entry.This means that short-range SUPERNORMAL Profit attracts new producers and so NORMAL profits only are made in long run equilibrium i.e. where AR = AC.

As more firms enter the market, the demand curve for any existing firm moves to the left as consumers opt to buy products offered by new or alternative companies.The demand curve continues to move to the left until it is tangential to the AC curve.At this point , the monopolistic competitive firm is at its profit maximising level of output( because MR = MC ) but is also making normal profit ( beacuse AR = AC ).​​​​​​Price is P1 and Quantity is Q1 at which firm is making Normal Profit in the long run.

•Price and Cost MR Output TAR