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Chapter 13: Problem 1

What are the key factors that determine the profitability of a firm in a monopolistically competitive market?

Short Answer

Expert verified
The key factors that determine the profitability of a firm in a monopolistically competitive market are: degree of market power, cost efficiencies, product differentiation and demand, and the broader market dynamics.

Step by step solution

01

Identification of Market Structure

In economics, monopolistic competition is a type of imperfect competition. It refers to a market structure where a large number of small firms compete against each other; however, all of them sell slightly different products. These differences take place in terms of product differentiation, branding, quality, etc.
02

Profit Determining Factors

Under monopolistic competition, the profitability of a firm can be determined by several key factors. Let's discuss these factors:
03

Factor 1: Degree of Market Power

One significant factor that determines profitability in this type of market is the degree of market power that a firm holds. Because products are differentiated under monopolistic competition, each firm has some degree of market power, meaning they can set their own price to a certain extent. Firms with a relatively higher degree of market power can likely charge higher prices, increasing profitability.
04

Factor 2: Cost Efficiencies

Cost efficiencies also play a critical role. The lower the cost of production, the higher the profits a firm can achieve, all else being equal. This can be achieved through scale economies, efficient operations, lower input costs, etc.
05

Factor 3: Product Differentiation and Demand

Another key factor is product differentiation and demand for the product. The more a firm can differentiate its product from others in the market, the more it can potentially charge, due to lower substitution effect. Also, the higher the demand for such differentiated product, the more profit a firm can make.
06

Factor 4: Market Dynamics

Finally, overall market dynamics including the level of competition, entry and exit of new firms, and consumer preferences also play a key role in determining profitability of a firm in monopolistically competitive market.

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Most popular questions from this chapter

In \(1916,\) Ford Motor Company produced 500,000 Model T Fords, at a price of \(\$ 440\) each. The company made a profit of \(\$ 60\) million that year. Henry Ford told a newspaper reporter that he intended to reduce the price of the Model \(\mathrm{T}\) to \(\$ 360\), and he expected to sell 800,000 cars at that price. Ford said, "Less profit on each car, but more cars, more employment of labor, and in the end we get all the total profit we ought to make." a. Did Ford expect the total revenue he received from selling Model Ts to rise or fall following the price cut? b. Use the information given above to calculate the price elasticity of demand for Model Ts. Use the midpoint formula to make your calculation. (See Chapter 6 , page \(186,\) if you need a refresher on the midpoint formula.) c. What would the average total cost of producing 800,000 Model Ts have to be for Ford to make as much profit selling 800,000 Model Ts as it made selling 500,000 Model Ts? Is this smaller or larger than the average total cost of producing 500,000 Model Ts? d. Assume that Ford would make the same total profit when selling 800,000 cars as when selling 500,000 cars. Was Henry Ford correct in saying he would make less profit per car when selling 800,000 cars than when selling 500.000 cars?

Why does a local McDonald's face a downward-sloping demand curve for its Quarter Pounders? If a McDonald's raises the price of Quarter Pounders above the prices other local fast-food restaurants charge for hamburgers, won't it lose all its customers?

What is the difference between zero accounting profit and zero economic profit?

Some companies have done a poor job protecting the images of their products. For example, Hormel's Spam brand name is widely ridiculed and is associated with annoying commercial messages received via e-mail. Think of other cases of companies failing to protect their brand names. What can companies do about the situation? Should the companies rebrand their products?

Why is a monopolistically competitive firm not productively efficient? In what sense does a monopolistically competitive firm have excess capacity?
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