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Chapter 13: Problem 5

A student makes the following comment: I can understand why a perfectly competitive firm won't earn a profit in the long run because it charges a price equal to marginal cost. But a monopolistically competitive firm can charge a price greater than marginal cost, so why can't it continue to earn a profit in the long run?

Short Answer

Expert verified
A monopolistically competitive firm cannot continue to earn a profit in the long run because of the low barriers to entry. This situation allows new firms to enter the market when they see others making a profit. The consequent increase in competition and decrease in demand eliminates the companies' ability to charge more than the marginal cost, which erodes the profit. On the other hand, perfectly competitive firms do not make long-term profits because they are price takers and can’t set a price higher than the marginal cost.

Step by step solution

01

Characteristics of a Monopolistically Competitive Firm

A Monopolistically competitive firm is a type of market structure where several or many sellers produce similar, but differentiated products. Differentiated products are the key character of such firms, which means products are somewhat different from each other in branding, quality, design, features, location and more. This gives the firm some amount of market power to set its own price, which is often higher than the marginal cost.
02

Entry and Exit in the Long Run

In the long run, if firms earn positive economic profits, this will attract new firms into the market, since there are few barriers to entry in monopolistic competition. As new firms enter, the demand for the product of the existing firms will decrease, because buyers now have more products to choose from. This decrease in demand decreases the price and profit of the existing firms until they reach a state of zero economic profits.
03

Comparing Perfect Competition and Monopolistic Competition

In contrast, in perfect competition, firms cannot earn long-term profits because they are price takers, they settle for the equilibrium price fixed by market supply and demand. Unlike a monopolistically competitive firm, they do not have the ability to differentiate their product or set its price. Thus, any profit they make will quickly vanish due to the price being equal to the marginal cost.

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Most popular questions from this chapter

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?

An article in the Wall Street Journal discussed the sidewalk vegetable stands in New York City's Chinatown. About 80 of these small vegetable stands operate along a handful of streets in that neighborhood. Most supermarkets buy vegetables from large wholesalers. In contrast, the entrepreneurs who run the stands in Chinatown buy from smaller wholesalers located in the neighborhood. These wholesalers, in turn, buy primarily from smaller family farms, some located overseas. Because these wholesalers make several deliveries per day, the owners of the stands do not have to invest in substantial storage space and the refrigerators that supermarkets use to keep vegetables fresh. The reporter compared prices for vegetables sold by these stands with vegetables sold by her supermarket: "In almost every case, Chinatown's prices were less than half what I would pay at the supermarket. Among the bargains: broccoli for 85 cents a pound, \(\$ 1\) each for pomegranates, oranges for a quarter." a. Is it likely that the owners of these vegetable stands are earning an economic profit? Briefly explain. b. Why doesn't competition among supermarkets drive the prices of vegetables they sell down to the prices of the vegetables sold in the Chinatown stands?

What effect does the entry of new firms have on the demand curve of an existing firm in a monopolistically competitive market?

Is it possible for marginal revenue to be negative for a firm selling in a perfectly competitive market? Is it possible for marginal revenue to be negative for a firm selling in a monopolistically competitive market? Briefly explain.

Does the fact that monopolistically competitive markets are not allocatively or productively efficient mean that there is a significant loss in economic well-being to society in these markets? In your answer, be sure to define what you mean by "economic well-being."
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