Question

1. Draw and label a graph depicting a monopolistic market from the perspective of a single firm. Make sure you illustrate the profit maximizing price and quantity .

   1. Start with a graph depicting market equilibrium for the monopolistic market .

   2. Modify the graph to demonstrate that the price at the profit maximizing level of output is above the average variable cost curve, but below the average cost curve .
   3. Is the firm making a profit or loss ?
   4. Will the firm decide to continue to produce in the short-run (will it shutdown)?
   5. Will the firm decide to continue to produce in the long-run (will it leave the market)?

Answer 1

Below is the graph of a monopolistically competitive single firm. There is a market equilibrium for the monopolistic market at quantity Q0 and price P2. This is determined by MR = MC rule.

The price P2 at the profit maximizing level of output is above the average variable cost P3 but below the average cost P1

Since price is less than ATC, there are currently economic losses at Q0 and P2.

Firm will continue to produce in the short-run and will not shut down since P > AVC where Minimum AVC is the shut down price.

Firm will leave the market because in the short run it was bearing economic losses. Hence, it may decide to leave it these losses persist in long run