Question

[2b] A monopolistic competitive firm has a temporary monopoly and then loses it and returns to normal profit. Graph and explain both conditions.

Answer 1

A monopolistic competitive firm:-

Monopolistic competition characterizes an industry in which many firms offer products or services that are similar, but not perfect substitutes. Monopolistic competition occurs when an industry has many firms offering products that are similar but not identical.Unlike a monopoly, these firms have little power to set curtail supply or raise prices to increase profits.Firms in monopolistic competition typically try to differentiate their product in order to achieve in order to capture above market returns.

Monopolistic competition tends to lead to heavy marketing, because different firms need to distinguish broadly similar products. One company might opt to lower the price of their cleaning product, sacrificing a higher profit margin in exchange—ideally—for higher sales.

Thus, Monopolistic competition is a type of imperfect competition such that many producers sell products that are differentiated from one another.

• D = Market Demand
• ATC = Average Total Cost
• MR = Marginal Revenue
• MC = Marginal Cost

As can be seen in this graph, the market price charged by the monopolistic competitive firm = the point on the demand curve where MR = MC.

Short-Run Profit = (Price - ATC) × Quantity

Note:- If the average total cost exceeds the market price, then the firm will suffer losses, equal to the average total cost minus the market price multiplied by the quantity produced. Losses will still be minimized by producing that quantity where marginal revenue = marginal cost, but eventually the firm either must reverse the losses or be forced to exit the industry.

  A monopolistic competitive firm has a temporary monopoly and then loses it and returns to normal profit.:-

Monopolistically competitive firms maximize their profit when they produce at a level where its marginal costs equals its marginal revenues. Because the individual firm's demand curve is downward sloping, reflecting market power, the price these firms will charge will exceed their marginal costs.

If the competitive firms in an industry earn an economic profit, then other firms will enter the same industry, which will reduce the profits of the other firms. More firms will continue to enter the industry until the firms are earning only a normal profit.

However, if there are too many firms, then firms will incur losses, especially the inefficient ones, which will cause them to leave the industry. Consequently, the remaining firms will return to normal profitability. Hence, the long-run equilibrium for monopolistic competition will equate the market price to the average total cost, where marginal revenue = marginal cost, as shown in the diagram below. Remember, in economics, average total cost includes a normal profit.