Question

A monopolistically competitive firm is currently producing 20 units of output. At this level of output the firm is charging a price equal to $20, has marginal revenue equal to $12, has marginal cost equal to $12, and has average total cost equal to $24. From this information we can infer that

		firms are likely to leave this market in the long run.
		the firm is currently maximizing its profit.
		All of the above are correct.
		the profits of the firm are negative.

The traditional view of monopolistic competition holds that this type of industrial structure is inefficient because

		consumers do not have enough choice among the product varieties available.
		there are too few firms to reach an efficient level of production.
		more advertising is needed to inform customers about product differences.
		firms do not operate at the output that minimizes average costs.

Suppose that in a competitive market the equilibrium price is $3.50. What is marginal revenue for the last unit sold by the typical firm in this market?

		less than $3.50
		exactly $3.50
		The marginal revenue cannot be determined without knowing the actual quantity sold by the typical firm.
		more than $3.50

Answer 1

(1)

The correct answer is (c) All of the above are correct

In order to maximize profit a monopolistic competitive firm produces that quantity at which Marginal Revenue = Marginal Cost. Here Marginal Revenue = Marginal cost = 12. Hence, the firm is currently maximizing its profit, so option (b) is correct.

In the long run there is no fixed cost and hence If firms are incurring negative profits then they will exit the market. Here firm is maximizing profit and still earns profit = TR - TC = PQ - ATC*Q = 20*20 - 24*20 = -80 (where ATC = Average total cost, P = price , Q = quantity TR = Total Revenue and TC = Total Cost). Hence they are incurring loss and so option (d) is correct and as they are incurring negative profits and in the long run there is no fixed cost and hence, they will exit the market. So option (a) is also correct and hence all of the above are correct.

So, the correct answer is (c) All of the above are correct.

(2)

The correct answer is (d) firms do not operate at the output that minimizes average costs.

In the monopolistic competitive market firms produced differentiated products and hence consumers have lots of varieties to produced and hence option (a) is incorrect.

In a monopolistic competitive market there are very less barriers because they produced differentiated product and hence because of this there are lots of firms available in the market and hence option (b) is incorrect.

In a monopolistic competitive market advertisement is used by a firms to increase there control over the market but this is not a reason for industrial structure is inefficient. Hence option (c) is incorrect.

The industry structure is most efficient when firms in the market is perfectly competitive because in order to maximize profit a perfect competitive firm produces that quantity at which P = MC(because for a perfect competitive firm P =MR as demand faces by a perfect competitive firm is horizontal) but in a long run a perfect competitive firm incurs 0 profit and hence, PQ = ATC*Q => P = ATC => P = ATC = MC in the long run and ATC = MC when ATC is at its minimum. Hence In the Perfect competitive firm produces at a point where ATC is at its minimum.

In the long run, Monopolistic competitive firm produces that quantity at which MR = MC and in the long run the demand faces by athis firm is downward sloping and hence MR is also downward sloping because of this MR = MC does not intersect where ATC is minimum(It intersect at a quantity lesser than the quantity where ATC is minimum). Because of this Monopolistic competitive firm is inefficient.

Hence, the correct answer is (d) firms do not operate at the output that minimizes average costs.

(3)

The correct answer is (b) exactly $3.50

A demand curve faced by a perfect competitive firm is price horizontal because it supply any quantity at a price decided by a market and supply all quantity at a constant price(i.e. Price is independent of quantity) because they are price takers.

So, Total Revenue(TR) = PQ => Marginal Revenue = d(TR)/dQ = d(PQ)/dQ = P(constant).

Hence P = MR for a perfect competitive firm.

As here Price = 3.5 So, Marginal Revenue is 3.5 for any quantity of good.

Hence, marginal revenue for the last unit sold by the typical firm in this market is $3.5

Hence, the correct answer is (b) exactly $3.50