4. Is monopolistic competition efficient? Suppose that a firm produces polo shir

Question

4. Is monopolistic competition efficient? Suppose that a firm produces polo shirts in a monopolistically competitive market. The following graph shows its demand curve, marginal revenue (MR) curve, marginal cost (MC) curve, and average total cost (ATC) curve Place a black point (plus symbol) on the graph to indicate the long-run monopolistically competitive equilibrium price and quantity for this firm. Next, place a grey point (star symbol) to indicate the minimum average total cost the firm faces and the quantity associated with that cost 2 9 2 100 Mon Comp Outcome 1 a 70 Min Unit Cost TC a 30 MC 10 MR Demand 0 10 20 30 4050 60 70 80 90 100 QUANTITY (Thousands of shirts)

Explanation / Answer

Given the profit­maximizing choice of output and price, the shop is earning negative profit, which means there are more shops in the industry than in long­run equilibrium.

Firms are not price takers.

Price is above marginal cost.

REASON : Under monopolistic competition, many firms compete for the same set of customers. Each firm produces a product that is at least somewhat differentiated from those of other firms, while entry in the market is easy. Because of these characteristics, monopolistically competitive firms resemble monopolists in that they are not price takers. Rather, they face downward­sloping demand curves for their product? thus, the profit­maximizing price is always above marginal cost which implies that monopolistically competitive firms allocate resources inefficiently. However, economic profit for monopolistic competitors, unlike for monopolies, is driven to zero in the long run, as demand for each firm's product adjusts with the entry and exit of other firms until price equals average total cost

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