Question 10.1
Of the following characteristics, which one applies exclusively to a monopolistic competitive firm?
A) It always earns a profit.
B) It produce differentiated product.
C) It can sell all it wants to at the market price.
D) It has no barriers to entry.
E) It has a range of prices it can charge for its output.
The correct answer is (B).
Monopolistic competitive firm competes from each other by differentiating their products so that each firm can have some market power.
Question 10.2
The similarity between monopoly and monopolistic competition is:
(a) There are barriers to entry
(b) They sell differentiated product
(c) There is perfect information
(d) There is long run normal profit
(e) The price is higher than marginal revenue
The correct answer is (e).
For monopoly and monopolistic competition, the demand curve is downward sloping and so marginal revenue curve is below the demand curve.
To sell one more unit the firms need to charge a lower price for all units.
Thus price is larger than marginal revenue for both market structures.
• Question 10.3
The similarity between perfect competition and monopolistic competition in the long run is:
(a) They both produces at the lowest point of the ATC
(b) They both charge a price equals marginal cost
(c) They both earn normal profit
(d) The number of firms are the same
(e) Firm’s demand curve is horizontal
The correct answer is (c).
There is free entry and exit of firms in perfect competition and monopolistic competition. In the long run
Profits will induce more firms to enter the industry and push down prices
Loss will lead to firms leaving the industry and push up prices
All firms earn zero economic profit in the long run.
Question 10.4
(a) Consider a monopolistic competitive firm selling shoes and make a normal profit. How can it differentiate its product in order to make economic profit?
(b) If the firm is able to differentiate successfully and earns an economic profit in the short run. What will happen to this firm in the long run?
a) The firm can differentiate its product by:
(1) Changing the shapes, sizes, cutting, colours of the shoes
(2) Provide quality service and after sales services
(3) Innovate and provide better quality shoes
(4) Produce at a low cost and charge a low price
(5) Advertise vigorously
b) Due to free entry and exit, in the long run more new firms attracted by the profit will enter the industry.
Each new firm produces a differentiated product, thus provides more substitutes in the market and take away existing firms’ customers.
Existing firms demand curve shifts leftwards and becomes flatter until all firms can only break even in the long run.
Question 10.5
1) What are the effects of advertising in the monopolistic competitive market?
2) Draw the diagram of a monopolistic competitive firm that is earning an economic profit. Be sure to label all the curves. Indicate the area that equals the firm’s economic profit. Is this a long-run equilibrium? Why or why not?
1) Advertising increases cost to the firm and hence raises the ATC curve.
It may also create awareness of the firm’s product so that demand and marginal revenue increases and the firm can charge higher price
The firm may earn higher profit in the short run if the effect on price exceeds cost.
In the long run, all firms advertise and thus demand becomes more elastic, price drops until no more profit for each firm.
2. Please draw a downward sloping demand curve, a downward sloping MR curve, a U-shaped ATC curve and a U-shaped MC curve which intersects the ATC curve at the lowest point of ATC curve.
This is a short run equilibrium, not a long run equilibrium. In the long run equilibrium, all firms earn zero profit.
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