Question for Review Question 4 Page 345
1. Does a monopolistic competitor produce too much or too little output compared to the most efficient level? What practical considerations make it difficult for policymakers to solve this problem?
Monopolistic competitors produce too little output. To enforce marginal-cost pricing, policy makers would need to regulate all firms that produce differentiated products. Because these products are common in the economy, the burden of such regulation would be overwhelming. Thus, Monopolistic competitors can continue to price their products at what the consumer is willing to pay.
Problem and Application Problem 5, Page 346
2. You are hired as the consultant to a monopolistically competitive firm. The firm reports the following information about its price, marginal cost, and average total cost. Can the firm possibly be maximizing profit? If the firm is profit maximizing, is the firm in a long-run equilibrium? If not, what will happen to restore long-run equilibrium?
a. P < MC, P > ATC
If price is less than marginal cost the firm is not maximizing profit. it shout cut output until MR=MC. Since P>MR for a monopolistically competitive firm P>MC when it is maximizing profit.
b. P > MC, P < ATC
Here the firm could be maximizing profit, since P>MC. However it is not in a long run equilibrium because P ATC
If P=MC the firm is producing too much and not maximizing profit it should cut production until MR=MC. However since P>ATC it is making economic profits and therefore not in a long run equilibrium. In the long run more firms will enter the industry, reducing price, and restoring equilibrium where P=ATC.
d. P > MC, P = ATC
Here the firm could be maximizing profit because P>MC. it is also in long run equilibrium because P=ATC. Here economic profits are zero and there is no incentive for firms to either enter or exit the market.
Questions for Review Question 1, Page 366