Question

1. Leather Feet is one of many firms that is a supplier in the market for shoes. Leather Feet’s shoes are considered to be high-end and are known for a stylistic sensibility that sets them apart from other producers’ shoes. Many firms have entered and exited the market over the past few decades but none produces exactly the same shoes as Leather Feet.
   1. What kind of market structure best describes this shoe market? Support your answer with the relevant characteristics.

2. Assume that Leather Feet is currently earning positive short-run economic profits. On a correctly labeled diagram, show Leather Feet profit-maximizing output and price, as well as the area representing profits.

3. What happens to Leather Feet’s price, output, and profit in the long-run? Explain this change in less than two sentences and illustrate it on a new diagram.

4. Suppose that over time stylistic differences among shoe brands become more important to consumers. How would this change in attitudes affect the firm’s price elasticity of demand?

5. At the profit maximizing price you identified in part (b), is Leather Feet producing at the efficient scale? Support your answer with no more than two sentences.

Answer 1

1. It is monopolistic competitive market. Monopolistic competition arises when there many seller selling goods of the same nature but which are not completely identical, hence the goods various sellers cannot be perfect substitutes for one another. Here though there might be many producers of shoes, the Shoes manufactured by Leather Feet are distinctive high end, are know for their stylistic sensibility which seta them apart from their competitors products.

Monopolistic competition is a combination of monopolistic and perfect competitive market. Here there are many sellers and buyers trading with commodities that are differentiated and are not perfect substitutes for one another.

Here though many sellers are present in the market their products are distinctive and will have inherent features which will set them apart from those of their competitors. In a Monopolistic competition the nature of the products are identical but not necessarily its features and specifications, the product of each seller can be differentiated from those of its competitors through its distinctive features. Here the consumers have a wide vary of choices. The demand will eb elastic. In such market sellers usually spend a lot on marketing efforts to attract the consumers towards their products. Here the sellers try to offer their products at attractive prices. Each firm in a monopolistic competition is a price maker of their product as they enjoy a distinguished position. The firms can freely enter and exit the market in a monopolistic competitive market. The demand curve will be downward sloping for all the firms with the decrease in the price the demand for their goods will increase. Each firm can influence only some part of the total output of the industry.

2.  In the short run monopolistic firm can earn positive economic profits and this is achieved when the market price is above the  minimum point of AC. The equilibrium is determined when MR= MC, marginal cost curve is upward sloping at the point of intersection, Price should be greater then or equal to minimum AVC curve. If the price is greater then Minimum AVC it means the firm is earning positive economic profits.

P₁PRS is region representing the positive economic profit. 'q' is the profit maximizing quantity since at this point the MR = MC and this point is also at the minimum of AVC. The price above the minimum point of AVC indicating positive economic profits.

3. In the short run the monopolistic firms can earn abnormal profits but in the long run as more firms enter the market the supply will increase and the price will fall. The prices continue to fall until it becomes equal to minimum of LAC . In the firms under a monopolistic competition earn normal profits.The profit maximizing long run equilibrium of monopolistic firm is attained where the following condition are fulfilled :

• LMR = LMC
• LMC should be upwards sloping at this point of intersection.
• LAR = LAC = Price

The long run equilibrium is determined by the intersection of LMC and LMR. At this level the firm earns normal profit or economic profits. In the long run TR will be equal to TC.

4.The elasticity of demand in this case would contract. When the products become more distinctive and when their distinctive features gain more merit and value in the eyes of the consumers their inclination towards the product will increase and their demand will start becoming more inelastic. Their attitude towards the firms product will become more positive.

5. Yes the firm is producing at effective scale since the scale is determined by the point where MR= MC and the minimum point of AVC and hence that point of scale  is the equilibrium scale.