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Chapter 10: 2SCQ (page 251)

Continuing with the scenario in question 1, in the long run, the positive economic profits that the monopolistic competitor earns will attract a response either from existing firms in the industry or firms outside. As those firms capture the original firm’s profit, what will happen to the original firm’s profit-maximizing price and output levels?

Short Answer

Expert verified

If the monopolistic rival achieves positive economic profits, the effect on the original businesses profit maximising pricing and output levels invites a response from either current industry firms or firms outside the industry.

Step by step solution

01

Concept introduction

Monopolistic Competition: This is a type of imperfect competition in which a large number of producers sell differentiated items and there is long-term freedom of entry and exit.

02

Explanation

As long as the initial firm is making positive economic profits, other firms will respond in ways that reduce the original firm's earnings, creating a sense of rivalry.

This will result in a fall in demand for the original firm's products, a decrease in the profit maximising price, and a decrease in the profit maximising output level.

As a result, in monopolistically competitive markets, all firms will eventually receive zero economic profits.

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Most popular questions from this chapter

Does each individual in a prisoner’s dilemma benefit more from cooperation or from pursuing self-interest? Explain briefly.

Sometimes oligopolies in the same industry are very different in size. Suppose we have a duopoly where one firm

(Firm A) is large and the other firm (Firm B) is small, as the prisoner’s dilemma box in Table 10.4 shows.


Firm B colludes with firm AFirm B cheats by selling more output
Firm A colludes with firm B
A gets \(1000,B gets \)100A gets \(800, B gets \)200
Firm A cheats by selling more outputA gets \(1050, B gets\)50A gets \(500, B gets \)20

Assuming that both firms know the payoffs, what is the likely outcome in this case?

If the firms in a monopolistically competitive market

are earning economic profits or losses in the short run, would you expect them to continue doing so in the long run? Why?

Would you expect the kinked demand curve to be more extreme (like a right angle) or less extreme (like a normal demand curve) if each firm in the cartel produces a near-identical product like OPEC and petroleum? What if each firm produces a somewhat different products? Explain your reasoning.

Consider the curve in the figure below, which shows the market demand, marginal cost, and marginal revenue curve for firms in an oligopolistic industry. In this example, we assume firms have zero fixed costs.

a. Suppose the firms collude to form a cartel. What price will the cartel charge? What quantity will the cartel

supply? How much profit will the cartel earn?

b. Suppose now that the cartel breaks up and the oligopolistic firms compete as vigorously as possible by cutting the price and increasing sales. What will be the industry quantity and price? What will be the collective profits of all firms in the industry?

c. Compare the equilibrium price, quantity, and profit for the cartel and cutthroat competition outcomes.
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