Answer to Question #288676 in Microeconomics for mirha

Question

Suppose you manage a local grocery store and you learn that Imtiaz super Market is about to open a store near you.

Use the model of monopolistic competition to analyze the impact of this new store on the quantity of output your store should produce (Q) and the price your store should charge (P). Note, we are assuming you each sell one representative good.

Explain how the opening of this new store may affect your business. Be sure to address what can happen to your customers, supply and demand, and prices. What will happen to your profits? Show graphically and explain your reasoning in detail. 

Explain at least one strategy that could be used to defend your market share against the new store (e.g., address what you are going to do to keep your customers).

Answer 1

Monopolistic competitors do not have significant monopoly power, so the dynamics of demand will differ from that of the monopoly. Due to the fact that there is competition in the market, in the event of an increase in the price of the products of the first firm, consumers will turn to another, so the demand for the products of each of the firms will be elastic. The level of elasticity will depend on the degree of differentiation, which is a factor in the binding to the products of each of the firms. The optimal output of each firm is determined similarly to the case of pure monopoly. Based on the graph, it should be noted that the price is determined by the demand curve. The presence of profit or loss depends on the dynamics of average costs. If the ATC curve passes below Po, then the firm makes a profit (shaded box). If the ATC curve is higher, then this is the amount of loss. If the price does not exceed the value of average costs, then the firm stops activities.

The opening of a new store is not very good news for the former seller, so he will turn from a monopolist into a competitor and, consequently, income and profit will be in question. The price should be higher than the average cost.

In order to survive, the former company needs to produce heterogeneous, differentiated products that differ from those offered by competing firms. Differentiation can be horizontal or vertical (described below). Moreover, the products may differ from each other in one or a number of properties (for example, in chemical composition).