Consider the following four sets of curves depicting firms o

Consider the following four sets of curves depicting firms operating in monopolistically competitive markets. A) B) MR Quantity Quantity C) D) Quantity Quantity For each of the graphs above, simply state whether the firm depicted in the graphis making positive economic profit, negative economic profit, or zero economic profit in the short run a. b. C. d. If a firm operating in a monopolistically competitive market is making positive short run profits and wants to avoid having their profits erode in the long run, what must they do? e.

Solution

In a monopolistically competitive market, the firm produces at where the MR meets the MC. If that production point in the demand curve (of which corresponding price would be set) is higher than the ATC at that production, then firm is realizing economic profit. If the ATC and demand curve are same at that production level, firm realizes zero economic profit. If the ATC is above the demand curve at that production level, then the firm would face economic losses.

(a) Economic Profit, since the production level at which MR meets MC corresponds to higher demand price than the ATC.

(b) Economic Profit, reason analogous to part (a).

(c) Economic Loss, since the production level at which MR meets MC corresponds to higher ATC than the demand price.

(d) Zero Economic Profit, as at the production level where MR meets MC corresponds to demand price equal to the ATC. This is the usual case of any monopolistic firm in the long run, where the demand decreases and is tangent to ATC due to the fact that profits in the market calls for entries of firms.

(e) As the firm makes economic profit in the short run, the profit attracts visitor firms in the market, which reduces the demand, so much so that in the long run, the demand curve is tangent to the ATC of the firm. To avoid losses, and remain competitive in the market, following points should be incorporated