Chapter 15: Problem 5

Magnificent Blooms is a florist in a monopolistically competitive industry. It is a successful operation, producing the quantity that minimizes its average total cost and making a profit. The owner also says that at its current level of output, its marginal cost is above marginal revenue. Illustrate the current situation of Magnificent Blooms in a diagram. Answer the following questions by illustrating with a diagram. a. In the short run, could Magnificent Blooms increase its profit? b. In the long run, could Magnificent Blooms increase its profit?

Short Answer

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Answer: In the short run, Magnificent Blooms can increase its profit by reducing its production to reach the point where marginal cost (MC) equals marginal revenue (MR). However, in the long run, Magnificent Blooms cannot increase its profit as it will ultimately operate with a zero economic profit due to the entry of new firms into the market.

Step by step solution

Draw the Initial Diagram

Draw an initial diagram with the price (P) on the vertical axis and quantity (Q) on the horizontal axis. Include the average total cost (ATC), marginal cost (MC), and marginal revenue (MR) curves and label them accordingly.

Identify the Short-Run Equilibrium

First, remember that Magnificent Blooms is in a monopolistically competitive industry where it minimizes its average total cost and makes a profit. Locate the point where MC = ATC and draw a horizontal line from this point to the vertical axis (y-axis) to determine the price level. Next, draw a vertical line from the point where MC meets ATC to the MR curve. This gives the quantity produced at the short-run equilibrium.

Answer Question (a) - Short-Run Profit Increase

In the short run, to answer whether Magnificent Blooms can increase its profit, we need to analyze if they produce at the point where marginal cost (MC) equals marginal revenue (MR). Since Magnificent Blooms is currently producing at a quantity where MC is above MR, it can increase profit by reducing its quantity slightly. This will decrease the MC, leading to a point where the company can operate where MC = MR, maximizing its profit in the short run.

Draw the Long-Run Diagram

Draw a second diagram to illustrate the long-run situation with the same axis labels and ATC, MC, and MR curves. The diagram will look similar to the short-run diagram, but with one significant difference - the long-run equilibrium will be at the point where ATC is tangent to the demand curve (price).

Identify the Long-Run Equilibrium

In the long run, new firms will enter the market until there is no more economic profit. This implies that the long-run equilibrium will be at a point where the price level equals the minimum of the average total cost curve. Find the point where the ATC curve is tangent to the demand curve (it should be noted that under monopolistic competition, the firm's demand curve is downward sloping), and draw a vertical line from this point to the x-axis to identify the new long-run equilibrium quantity.

Answer Question (b) - Long-Run Profit Increase

In the long run, Magnificent Blooms cannot increase its profit because the industry will reach a point of zero economic profit. At this point, the firm will continue to produce at the same level, making only a normal profit. To summarize the results: a. In the short run, Magnificent Blooms can increase its profit by reducing its production to reach the point where MC equals MR. b. In the long run, Magnificent Blooms cannot increase its profit as it will ultimately operate with a zero economic profit due to the entry of new firms into the market.