Answer to Question #275041 in Microeconomics for stacey

Question

Why is it the case in a long-run monopolistically competitive equilibrium that the firm’s demand curve is tangent to its average cost curve? Why could it not be a long-run equilibrium if the demand curve “cut through” the average cost curve? (Max. 500 words)

Answer 1

In the long-run competitive equilibrium, the firm's demand curve will intersect its average cost curve.

The logic is that the demand curve that a monopolistic competitor faces is always more elastic than its marginal cost curve. This creates a "kink" at the intersection of the two curves. If one good is substituted away while both are sold together, then some consumers who use more of one goodwill buy less while others who purchase small portions of both goods may switch to make up for it. In other words, some consumers switch from buying substantial amounts on x product to buying more y products because they substitute away from purchasing substantial quantities on x product towards purchasing more y products because they substitute away from maximum quantities on x product

Monopolistically competitive firms are firms that face 'imperfect' competition (i.e., their competitors are not easily replaced by new entrants) and price their products in such a way that they earn an economic profit. This means that the monopolistic competitive firm is not concerned about other producers, but individual firms do compete with each other for customers because once this occurs there is either entry to the market (and all the customers) or exit of existing producer, due to inability to invest in capital goods like land or plant/equipment which might yield them higher marginal profits than what they can get right now.

When a firm enters a market

ranging from being "sub-competitive" to being so "sub-competitive" that it has no impact on the market because individual firms have only a small fraction of the industry's sales. In terms of economic efficiency, price competition among these firms is considered beneficial to consumers because each seeks to lower prices and increase sales in order to survive in the long run. One way for an individual firm to do this is by further reducing its average costs which continually squeezes its cost curves towards its minimum costs. It eventually reaches a point where the tangency point happens which results in an equilibrium level of pricing and quantity.

Answer: If the demand curve "cut through" ACC, it could not be a long-run equilibrium because if the firm lowered its price in order to lower the average cost of production, demand would shift to the right - which would lead to increased short-run profits.

There are two ways that a firm could produce at an output where ACC<MRP. One way is that that there is an available substitute. The other is through increased efficiency in production for this specific good type are simultaneously lowering the cost of production without impacting quality/efficiency for another good type or altering prices for other goods types. This might be possible in some cases when our country was relatively higher income and high skilled labor was available in rural areas to produce goods produced by people living.