Question

The market for laundry detergent is monopolistically competitive. Each firm owns one brand, and each brand has effectively differentiated itself so that it has some market power (i.e., faces a downward sloping demand curve). Still, no brand earns economic profits, because entry causes the demand for each brand to shift in until the seller can just break even. All firms have identical cost functions, which are U-shaped.

(a) Is this market in long-term or short-term equilibrium? Explain your claim?

Now suppose that the government does a study on detergents and finds out they are all alike. The public is notified of these findings as a result consumers drop allegiance to any particular brand. As a result of this event, discuss the long-run effects on the laundry detergent market. Specifically, answer the following questions:

(b) What will be the effect on the demand curve of firms in this market? Why?

(c) How will this event effect the market price of laundry detergent? Explain.

(d) How will each firm’s supply and sales change? Explain.

(e) Does this event increase or decrease the number of firms in this market? Why?

(f) What will happen to total quantity output in the laundry detergent market? Explain.

** Please do not just copy from the other answers. The problem is the same but the following questions are different. Thanks.

Answer 1

(a) Since the firms are earning no economic profits, the market is in long-term equilibrium.

(b) The demand curve will change from downward sloping to horizontal.

(c) In monopolistically competitive market, long-run equilibrium price is higher than what it would be if the market were perfectly competitive. This means when the market structure changes from monopolistically competitive to perfectly competitive, the price would be higher than the long-run equilibrium price. This implies that existing firms would be making economic profits. This will attract more firms into the market. As a result, supply curve will shift rightward and market price will fall.

(d) At a lower price, each firm will be selling a greater quantity.