MODULE 67: I NTRODUCTION TO M ONOPOLISTIC C OMPETITION

AVRIL GENAO CERDA

CHECK YOUR UNDERSTANDING

1. Suppose a monopolistically competitive industry composed of rms with U-shaped average total
cost curves is in long-run equilibrium. For each of the following changes, explain how the industry is
affected in the short run and how it adjusts to a new long-run equilibrium.
- a technological change that increases xed cost for every rm in the industry: when xed
costs increase, the rm will get a loss so it will exit and the more rms that do that, the easier
for the rms that are still there to recover it will be. They will end up at the zero pro t point and
restablish equilibrium in the new long run.
- a technological change that decreases marginal cost for every rm in the industry: when MC
is lower, more rms will be attracted and will make more money. As more and more rms go
in, the pro t will start to reduce in the long run up until where their economic pro t is 0.

2. Why is it impossible for rms in a monopolistically competitive industry to join together to form a
monopoly that is capable of maintaining positive economic pro t in the long run?
- a monopolistically competitive industry has limited barriers to entry therefore a monopoly that
was created wont make pro t like it used to since the more rms enter the less pro t they
individual recieve

3. Indicate whether the following statements are true or false, and explain your answers.
- Like a rm in a perfectly competitive industry, a rm in a monopolistically competitive
industry is willing to sell a good at any price that equals or exceeds marginal cost: FALSE
since although it is true that in perfect competition they are is willing to sell a good at any price
that equals or exceeds marginal cost, in a monopoly they will sell at a price over MC to get as
much pro t as they can

- Suppose there is a monopolistically competitive industry in long-run equilibrium that

possesses excess capacity. All the rms in the industry would be better off if they merged
into a single rm and produced a single product, but whether consumers would be made
better off by this is ambiguous: TRUE since rms are better off if they join all together and that
way they can earn higher pro ts. Since they are all smaller rms, if they get together their
costs will be much lower leaving them with a higher pro t.

- Fads and fashions are more likely to arise in industries characterized by monopolistic
competition or oligopoly than in those characterized by perfect competition or monopoly:
TRUE since fashion is all about different products which aren’t characteristics of monopoly or
perfect competition since those are with the same product, meanwhile monopolistic
competition or oligopoly do have product differentiation.


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 MULTIPLE CHOICE QUESTIONS

1. Which of the following is a characteristic of monopolistic competition?
a. a standardized product
b. many sellers: everything else is something they do not have
c. barriers to entry
d. positive long-run pro ts
e. a perfectly elastic demand curve

2. Which of the following results is possible for a monopolistic competitor in the short run?
I. positive economic pro t
II. normal pro t
III. loss
a. I only
b. II only
c. III only
d. I and II only
e. I, II, and III: these are all capable of happening for a monopolistic competitor since
depending on the demand curve they have and where the ATC curve is

3. Which of the following results is possible for a monopolistic competitor in the long run?
I. positive economic pro t
II. normal pro t
III. loss
a. I only
b. II only: when rms reach the zero economic pro t they reach normal pro t
c. III only
d. I and II only
e. I, II, and III
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4. Which of the following best describes a monopolistic competitor’s demand curve?

a. upward sloping
b. downward sloping: look at the demand curve ->
c. U-shaped
d. horizontal
e. vertical

5. The long-run outcome in a monopolistically competitive industry results in

a. inef ciency because rms earn positive economic pro ts.
b. ef ciency due to excess capacity.
c. inef ciency due to product diversity.
d. ef ciency because price exceeds marginal cost.
e. a trade-off between higher average total cost and more product diversity: differentiated
products come in when there are more rms in monopolistic competition and the avg total
cost would be higher when rms sell more.

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FREE RESPONSE QUESTIONS
1. Draw a correctly labeled graph for a monopolistically competitive rm that is unpro table in the
short run. Shade the area that represents the rm’s losses.

2. Draw a correctly labeled graph for a monopolistically competitive rm in long-run equilibrium. Label
the distance on the quantity axis that represents excess capacity.


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