Posted by Sally on .
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
I would think that the firm can’t possible be maximizing profit. The firm should raise price, so that price is greater than MC.Since the firm isn’t profit maximizing the firm should raise price, so that price is equal to ATC but greater than MC.
b. P > MC, P < ATC
The firm is maximizing profit. The firm is not in long-run equilibrium since the price is less than ATC.
c. P = MC, P > ATC
The firm is maximizing profit. The firm is not in long-run equilibrium since the price is greater than ATC.
d. P > MC, P = ATC
The firm is maximizing profit. The firm is in long-run equilibrium since the price is equal to ATC.
I think you are on the right track. Recall for a monopolistically competitive firm, the demand curve faced by the firm should be nearly flat (highly elastic). So, price and marginal revenue are nearly the same.
So, for a) raise price to at least MC, (perhaps a bit more). Since P starts greater than raising price will make P even more greater than ATC.
b) firm may or may not be maximizing. Price may be too high
c) As P is greater than ATC and is maximizing, there is no incentive for the firm to change anything. However, the industry may not be in equilibrium. Other firms, seeing profits to be made, may enter, which will increase supply and drive down price. P=ATC is a longrun condition for the perfectly competitive industry.
d) Again, P may be too high.