Problem 4 (Monopolistic Competition-Extra Practice) There is free entry and exit

Question

Problem 4 (Monopolistic Competition-Extra Practice) There is free entry and exit in the market for vodka. Before the year 2100, the for a very long time believed that different brands of vodka have unique flavor profiles and are therefore differentiated. On the 1st of January 2100, a highly regarded vodka ex pert revealed that actually, all vodka brands are chemically identical, and that it is impossible for any human being to actually taste any difference between different brands of vodka. Consumers now believe that all vodka brands are perfect substi- tutes. By 210, the market has settled into the new long run market equilibrium. market for vodka was in long run equilibrium. Consumers have 1. What is the initial (pre-2100) market structure of the market for vodka? 2. What is the post-2100 market structure of the vodka market? 3. Assume that every firm has the same costs of production as shown in the diagram below MC ATC Using the diagram, explain whether each of the following variables in- creases, decreases or stays the same for a typical firm between the years 2099 and 2102. (L.e. how do the long run equilibrium variables change.) (a) Price (b) Quantity QFirm ATC(Qim) (d) MC(QFm) (e) Profit

Explanation / Answer

1. Monopolistic competition , bcoz free entry & exit in long run with differentiated products , with large number of small firms

2. Perfect competition , since all products are perfect substitute.

3. A) price will fall bcoz market structure changes from monopolistic competition to perfect competition.

B) quantity of individual firm increases bcoz market structure changes from imperfect to perfect competition

C) ATC increases bcoz total output of individual firm rises

D) mc remains same

E) profit of firm remains same at normal level , bcoz in long run equlequilib firms in perfect competition & monopolistic competition earn normal profits only

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