Question

1. Draw a graph of a monopolistically competitive firm that is currently earning a short run profit. Be sure to include marginal revenue, demand, marginal cost and average total cost curves. What will happen to this firm as it enters the long run?

1b. What would you expect to happen to these initial firms as more and more pubs begin branching out into other markets?

Multiple Choice/True False Questions:

1. The fact that pubs are now competing with firms like McDonald’s for breakfast implies that the price for a hot breakfast should

a. RIse

b. Fall

c. Stay the same

2. The market in which pubs operate is considered monopolistically competitive. Which of the following is NOT a characteristic of monopolistic competition.

A. Zero long run profit.

B. Many small firms.

C. Homogeneous product

D. Easy entry into the market.

3. As more firms enter a market, demand for the product of any one firm will ______________ and become ________________.

A. Rise; more elastic

B. Fall; more elastic.

C. Rise; less elastic.

D. Fall; less elastic.

Answer 1

(1)

A monopolistically competitive firm maximizes profit by equating Marginal revenue (MR) and Marginal cost (MC) curves, and earns economic profit in short run if price is higher than average total cost (ATC). Since entry is free in such market, short run economic profit attracts new entry, and each firm's profit starts to decline with entry of more firms. The process continues until each firm produces at a point where MR equals MC and Price equals ATC, therefore profit is zero. However, Price equals ATC to the left of the minimum point of ATC curve, leaving the firm with excess capacity.

In following graph, short run is depicted in left panel and long run is depicted at right panel. In the left panel, short run equilibrium is at point A where MR intersects MC with price P0 and output Q0. Since ATC lies below P0, firm is earning positive economic profit equal to area P0BCD. The right panel shows long run equilibrium at point E where MR intersects MC with price P1 and output Q1. Since demand curve is tangent to ATC at price P1, economic profit is zero.

(1b)

(1) (a)

As more pubs (competitors in breakfast market) branches out to other market, it means that number of sellers will fall, lowering market supply. The market supply curve will shift leftward, increasing price and decreasing quantity.

(2) (C)

In monopolistically competitive market, each firm sells similar but differentiated (heterogeneous) products.

(3) (B)

Entry of more firms will decrease the demand for individual firms, and due to increased competition, firm demand curves will become more elastic since consumers will have more substitutes available.