3. (10 points) The diagram below shows the short run demand curve (D), marginal

Question

3. (10 points) The diagram below shows the short run demand curve (D), marginal revenue curve (MR), average total cost curve (ATC), and marginal cost curve (MC) for a firm in a monopolistically competitive market.

(a) What level of output should this firm produce? Explain.

(b) What price should this firm charge? Explain

(c) Will this firm earn a profit or will it earn a loss? Explain

(d) Would you expect entry or would you expect exit in this industry? Explain.

Explanation / Answer

(a) Firm will maximize profit by producing an output corresponding to intersection of MR & MC. From graph, when MR intersects MC,

Quantity = 24 units

(b) When quantity is 24 units, Price is $27 (From demand curve).

(c) When quantity is 24 units, ATC is $9 which is lower than price, therefore firm will make a profit.

(d) In monopolistic competition, entry and exit are free. So, new firms will enter then market being attracted by short run economic profit earned by firms. New entry will continue until all firms earn zero economic profit.

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