Econ Theory

3 Pages 659 Words

1. b) There is a discrepancy between the price at which a good sells and the minimum average total cost of a good’s production under monopolistic competition and not under pure competition. Unlike in a purely competitive scenario, the price and average total costs in a monopolistically competitive firm exceed the minimum average total cost at which the good could be produced. In a monopolistic competition less is produced at a higher price, which would cause substitution in a perfectly competitive market because there is no variety. Under monopolistic competition, however, there is a trade-off for less production and higher prices, because there is a variety in the products available and people want variety and are willing to pay a higher price to obtain it.
2. A monopolistically competitive firm moves towards equilibrium by setting the marginal revenue equal to the marginal cost and selling that quantity for the price given on its demand curve. At this point, the price charged is above average total cost and the monopolistic competitor is making a profit, thus enticing other firms to enter the market. As the other firms enter, the price is lowered, the share of the industry demand of each firm is reduced, and the demand curve shifts to the left. Firms continue to enter until the demand curve touches the average total cost curve. At this price and quantity profits have been driven to zero and there is no incentive for either entry or exit. At the point defined above a firm is said to reach equilibrium.
Even though there is no incentive at equilibrium for entry or exit, “equilibrium” is never really evident because as soon as a firm sees that profits are heading to zero there are options they can take to help drive out competition. A firm can take an industry out of equilibrium by differentiating its product from the similar products that other firms are producing even more so than they already are. By making their pro...