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Chapter 13: Problem 2

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

Short Answer

Expert verified
A monopolistically competitive firm is not productively efficient as it does not produce at the minimum of its average total cost curve. This is a result of market control which enables the firm to set its prices above marginal costs. Also, a monopolistically competitive firm has excess capacity because it produces less than the output at which average total cost is minimized. This is triggered by entry of new competitors, causing a leftward shift of the individual firm's demand curve till it intersects with the average total cost curve.

Step by step solution

01

Understanding Monopolistic Competition

Monopolistic competition is a type of imperfect competition such that many producers sell products that are differentiated from one another. They are not perfect substitutes, hence producers have some control over price.
02

Productive Efficiency in Monopolistic Competition

A monopolistically competitive firm is not productively efficient because it does not produce at the lowest point on its average total cost curve. This is mainly due to product differentiation, which allows firms to maintain some level of market control and keep prices above marginal costs.
03

Excess Capacity

Excess capacity refers to a situation in which a firm is producing at a lower scale of output than it has been designed for. A monopolistically competitive firm has excess capacity because in the long run, new entrants move into the market, causing the demand curve of each firm to shift inward, until they are no longer covering costs, leading to a situation where they could potentially produce more, but the market demand is simply not there.

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Most popular questions from this chapter

Purell announced that the new chemical formula for its hand sanitizer was so effective that "just 1 squirt of Purell Advanced Hand Sanitizer kills as many germs as two squirts of any other national brand." If Purell succeeds in convincing consumers that its claim is correct, would its demand curve become more elastic or less elastic? Briefly explain.

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

A firm that is first to market with a new product frequently discovers that there are design flaws or problems with the product that were not anticipated. For example, the ballpoint pens made by the Reynolds International Pen Company often leaked. What effect do such problems cause for the innovating firm, and how do these unexpected problems create possibilities for other firms to enter the market?

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?

There are many wheat farms in the United States, and there are also more than 2,000 Panera Bread restaurants. Why, then, does a Panera restaurant face a downwardsloping demand curve, while a wheat farmer faces a horizontal demand curve?
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