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Econ Theory

Econ Theory

1. b) There is a discrepancy between the price at which a good sells and the minimum average total cost of a good’s production under monopolistic competition and not under pure competition. Unlike in a purely competitive scenario, the price and average total costs in a monopolistically competitive firm exceed the minimum average total cost at which the good could be produced. In a monopolistic competition less is produced at a higher price, which would cause substitution in a perfectly competitive market because there is no variety. Under monopolistic competition, however, there is a trade-off for less production and higher prices, because there is a variety in the products available and people want variety and are willing to pay a higher price to obtain it.

2. A monopolistically competitive firm moves towards equilibrium by setting the marginal revenue equal to the marginal cost and selling that quantity for the price given on its demand curve. At this point, the price charged is above average total cost and the monopolistic competitor is making a profit, thus enticing other firms to enter the market. As the other firms enter, the price is lowered, the share of the industry demand of each firm is reduced, and the demand curve shifts to the left. Firms continue to enter until the demand curve touches the average total cost curve. At this price and quantity profits have been driven to zero and there is no incentive for either entry or exit. At the point defined above a firm is said to reach equilibrium.

Even though there is no incentive at equilibrium for entry or exit, “equilibrium” is never really evident because as soon as a firm sees that profits are heading to zero there are options they can take to help drive out competition. A firm can take an industry out of equilibrium by differentiating its product from the similar products that other firms are producing even more so than they already are. By making their product better in some way or patenting a special aspect of the product, the firm can shift its demand curve because consumers will be willing to pay a higher price for the product, thus increasing profits for the firm. A firm in the industry that can sustain a loss for a short amount of time also has an option to lower their prices below the ATC, making sure not to go below the fixed cost. This causes firms that can not afford to compete with the low price to exit the market, giving the firm a higher market share.

Profit = $240.00-(15*$13.00)= $45.00

a) Profit Maximizing Quantity = 15 units

A monopoly sets marginal revenue equal to marginal cost and sells the quantity for the price given on its demand curve.

b) Price = $16.00 or $16.50 (its hard to tell)

Average Total Cost = $13.00 or $13.50 (its hard to tell)

Following the quantity found in part a) to the demand curve and tracing that over to the price/unit, sets the price. Average total cost is the price/unit at the quantity given in part a).

Profit = ($16.00)(15) – ($14.00)(15) = $45.00

5. A monopoly and a monopolistically competitive model calculate profits and make output decisions similarly, initially. When the models are extended into the next time period they become different because monopolistically competitive industries have attracted new firms to their market. Entry into the entry causes the market share of the firms to decrease the demand curve to shift to the left, prices to decrease, and profits to decrease. This affects all the calculations made in question number four. This is different because unlike monopolistically competitive industries, a monopoly has barriers to entry and no other firms compete with the profit maximizing price. The only changes in a monopoly are demand related.


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