Answer to Question #202517 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

a)

A firm is able to maximize its profits by supplying its output at a point where marginal revenue equals marginal cost. When marginal revenue is higher than marginal cost, the firm earns greater profits by increasing its output. When marginal revenue falls below marginal cost, the firm makes a loss and therefore, it must reduce its output.Therefore, profits are maximized when the firm chooses the level of output where its marginal revenue equals its marginal cost.

From the above diagram, the equilibrium quantity supplied is 29 units ( the intersection of the marginal cost and marginal revenue curves) At 29 units of output, average total cost is $6.90 (point c on the average total cost curve in Figure ). The firm's profits are shown by the area of the shaded rectangle labeled abed.

b)

In the long run, a monopolistic competitive firm will still produce at a point where marginal cost equals marginal revenue. However, the demand curve shifts to the left because of entry of other companies to the market. The demand curve shift is caused by reduced demand for an individual company’s products as a result of increased competition.

As a result, economic profits are reduced, depending on the magnitude of the entry of new players. Individual companies therefore are no longer able to sell their products at above-average cost.

Firms in monopolistic competition earn zero economic profit in the long run. This discourage new entrants in the industry.