Question

A monopolistically competitive sneaker firm is currently in long run equilibrium.

1. Graph the firm in long run equilibrium. Be sure to label all of the curves and the profit-maximizing price and quantity.
2. The price of rubber decreases. Rubber is a major component in the production of sneakers. Draw a new graph that shows the change in the profit maximizing price and quantity of sneakers. Be sure to shade the area of loss or profit.

Answer 1

The initial long run equilibrium in the monopolisitic competition occurs at the intersection point of marginal revenue and marginal cost curve, thus, Qm represents equilibrium quantity and Pm represents equilibrium price level charged by the monopolistic competitive firm. A decline in the price of rubber will shift the marginal cost and average cost curves of the economy downwards to MC' and AC' and thus new equilibrium occurs at intersection point of MC' and MR increasing the equilibrium quantity to Qm' and decreasing price to Pm and the red shaded area represents profit of the firm.