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Chapter 13: Problem 1

Why doesn't a monopolistically competitive firm produce where \(P=M C\), as a perfectly competitive firm does?

Short Answer

Expert verified
A monopolistically competitive firm doesn't produce where P=MC, unlike a perfectly competitive firm, because it can influence the product's price by adjusting its output level. The firm faces a downward-sloping demand curve and increases quantity sold by reducing price. So, it maximizes profits where marginal cost equals marginal revenue (MC=MR), not at P=MC.

Step by step solution

01

Understanding Perfect Competition

In a perfectly competitive market structure, firms are price takers. That is, they don't have the power to influence the market price. Therefore, they tend to produce where their marginal cost (MC) equals the market price (P). Consumers have perfect information, and there's free entry and exit in the market. This leads the firm to make zero economic profit in the long run.
02

Understanding Monopolistic Competition

Under monopolistic competition, firms have some degree of market power. This means firms are able to influence the price of their own product by adjusting their level of output. The products are differentiated, so each firm's product has its own demand curve. This demand curve is downward sloping, meaning that the firm can increase the quantity sold (demand), by reducing the price.
03

Distinguishing Output Levels between the Two Market Structures

A monopolistically competitive firm faces a downward-sloping demand curve and, by reducing the price, the firm can sell more quantities, unlike firms under perfect competition that need to produce where their MC equals the market price (P=MC), because the firm cannot alter its output level to alter the market price. Instead, in monopolistic competition, the firm maximizes profit where marginal cost equals marginal revenue (MC=MR) but does not equate to price (MR != P),

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Most popular questions from this chapter

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