Answer to Question #202516 in Microeconomics for innocent kampumba

Question

With graphical illustrations of the market structures, explain

a) the case of profit maximizing firm in the short run

b) the case of a loss making Monopolistic competitive firm in the long run

Answer 1

Solution:

a.). For any market structure, a firm will maximize its profits at the point where the Marginal Revenue (MR) is equal to the Marginal Cost (MC). The profit maximizing quantity will occur at that particular point where MR = MC. The firm will then charge what the market is willing to pay. A dotted line drawn straight up from the profit-maximizing quantity to the demand curve displays the profit-maximizing price for the firm. The price will be above the Average Total Cost (ATC), which means the firm is making profits.

 

This is depicted by the below graph. From the graph the profit-maximizing output is 4 units, while the profit maximizing price is 32. The point between 15 and 25, where ATC is at its minimum point and the demand curve represent the total profits, the firm is earning.

 

 

b.). In the long run, firms in a monopolistic competition still produce at the point where MR is equal to MC. However, since many firms will start entering the market, the demand curve will shift to the left. This is because of a reduction in demand for an individual firm’s goods, including reduced profits as a result of increased competition. As such, the firms will not be able to sell their products at above the average total cost. Also, the firms will incur excess capacity since they produce less than the minimum-cost output, resulting to higher costs. As more firms continue to enter the market, the firms will only earn normal profit and zero economic profit. However, if there are too many firms, some firms will start earning losses since ATC will be higher than the demand curve.

 

This is depicted by the below graph.