Question

Question 1 :

1. What effect does the entry of new firms have on the economic profits of existing firms in a monopolistically competitive market? Elaborate your answer with appropriate examples.
2. Why a firm remains in business even by earning zero economic profit? Elaborate your answer.

Question2:

1. Elaborate the three most important characteristics of an oligopoly market. Give three examples of oligopolistic industries in Saudi Arabia.
2. What is a patent? If a patent serves as barrier to entry, why do governments issue patents?

Question 3:

What are the determinants of demand for labor and supply of labor? How the equilibrium wage rate is determined in labor market? Why a janitor gets lower wage than a heart surgeon? Explain

Question 4: Why some governments resort to price ceiling and price floor for some goods and services? Describe three most important disadvantages of price ceiling and price floor? In what conditions do you think that price ceiling and price floor may contribute to welfare of people?

Expert Answer

• Sayantan Banerjee answered this

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  AS PER CHEGG POLICY, I CAN ONLY ANSWER THE 1ST QUESTION

  In a mopolistically competitive market, firms are not price takers. They are price makers. So they decide their own price. So in the short run, firms can have supernormal profits. That is they can set any price they want to and get high economic profits. However, since the market is very much price elastic, so unless the product is differentiated, it is not possible to continue this supernormal profits.

  Here we now consider multiple firms whose products are not similar but very near substitutes.

  Now let's say there is a new entrant in the market. The barriers to entry are quite low. So they can easily enter the market. What is the incentive of a new entrant? Since the economic profits are very high, a new firm is enticed to join the market.

  As they join the market, the quantity of products in supply increases. This leads to a lowering of the supply curve. Due to this, the equilibrium price will also go down. Now since the cost of production remains the same, the economic profit of the firm goes down.

  So with each new entry in the monopolistically competitive market, the economic profit of all the firms go down to a point where the economic profit is zero.

  At this point of time, no new firms have any incentive to join the market as they would not get any profit. In spite of that, let us consider that some firm joins. This reduces economic profit from 0 to negative for all the firms. As a result, firms will start to leave the market. If more than one firm leaves, the profits go up and become positive. This creates space for new entries. So the number of firms goes on increasing or decreasing as the case may be till they converge to a optimal number where the economic profit is zero.
  
  
  So if a new firm enters a monopolistically competitive market, in the short run, the economic profits of all the firms decrease and in the long run they become zero.

  Let us consider an example of restaurants. There are many restaurants and infinite customers. The restaurants have priced their food such that they make an economic profit EP. Now there is a new entrant. They price their food lower(to attract customers) and their food is a good substitute of what is available in the market. SO people will start moving to them. Now either they increase prices to reap more profit, or if they have the bandwidth to accomodate the increased rush, they keep on getting customers. This leads to other restaurants to lower their prices as well or face losses. Thus the overall market has a lower price. this means the economic profit for all the firms have gone down.

  Now there is another newer entry at a lower price. So other players can also start undercutting their food prices.

  These new entrants keep on coming and thus prices keep getting lowered till one restaurant has reached the point of Zero Economic Profit. No restaurant will be able to cut prices beyond this point. So All restaurants will converge to this price point to get a level playing field. Thus in the long run, the economic profit becomes zero.

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Answers from our experts for your tough homework questions

Answer 1

Answer 1A - In the monopolistic market , the profit maximisation condition is the MR = MC. There is the freedom of the entry and exit in the market. In the long run , if the firms earn the positive economic profits , this will attract the entry of the new firms in the market. This will reduce the revenue for the other firms in the market and the postive economic profits will be reduced to the nromal profits.

Suppose X earns the profit when MR > MC. On seeing this , firm Y will also enter the market with the hope of profits. This will increase the competition in the market and bring the revenue of X down and settle at MR = MC.

Question 1 - B

The firms in long run earn the normal profits . They are able to earn back , both the fixed and the variable cost of doing business. They do not have to lose anything. The monopolistic market also practises price discrimination. Hence , it does not exit the market in case of normal profits as he is not earning losses.