Question

1. (a) why do firms in a monopolistic competitive market have to worry about setting a price while firms in perfect competition do not.

(b) Give an example of each of the above types of markets

(c) As a business owner, which market would you rather be in? (why?)

(d) What are firm long-run economic profits in monopolistic competitive industries? (why?)

Answer 1

What is Perfect Competition and Monopolistic Competitive Market?

All types of Markets are classified on the basis of the intensity of competition among producers in a particular industry. The intensity of competition determines how much freedom and power an individual producer enjoys in determining the price. Consequently, the more the intensity of competition in a particular industry, the less influence particular producer has on the price.

Answer a. In perfect competition, since their are large number of buyers and sellers ( market share of one particular firm like a drop in ocean) producing homogeneous products, price is determined by the demand and supply of the entire market. So if a particular producer charges higher price than the price determined by demand and supply, consumers would switch to other producer producing the same product at less price.

While in Monopolistic Competition, there are large number of sellers (each firm has small share) and products of each firm is a close substitute of other firms. Therefore prices of products of different producers is slightly different. If firm in a monopolistic market increases price, consumer would switch to products of other company.

Thus, firms in a monopolistic competitive market have to worry about setting a price while firms in perfect competition do not worry about prices.

Answer b.  Although it is very difficult to find Perfect Competition in real world, but some industries resemble Perfect competition. For Instance Food and Beverages Industry.

Toothpaste Industry is an example of monopolistic competition.

Answer c. I would prefer to operate in soap market (monopolistic market). Though products are close substitutes but if an entrepreneur doesn't compromise on quality, customer retention would be more and new customer would also purchase my product (toothpaste).

Answer d. Firm in Monopolistic competition would earn normal profits. Reason being, if producer is earning more than normal profits, new firms will enter the market and thus producer has to decrease prices of products as the goods in monopolistic markets are close substitutes.

Answer d. In long run,