Question

Firm X is a monopolistic competitor that produces Good X. If the market for Good X was perfectly
competitive, would it have charged the same price and earned the same amount of profit that it
does now? Explain your answer with the help of relevant diagrams.

Answer 1

A monopolistic competitor faces a downward sloping demand curve, and maximizes profit by equating MR and MC, while MR curve lies below its demand curve. Therefore, price is higher than MC.

In contrast, a perfect competitor maximizes profit by equating Price and MC, while its MR curve and demand curve are identical. Therefore, price is equal to MC.

So, in perfect competition, price is lower and quantity is higher. Therefore, a monopolistically competitive firm earns higher profit.

In following graph, monopolistic competitor maximizes profit at point E where MR intersects MC with price P0 and quantity Q0. Corresponding profit is P0BFG. A perfect competitor maximizes profit at point H where Demand (D) intersects MC with lower price P1 and higher quantity Q1. Corresponding profit is P1HJK. As is seen,

P0BFG > P1HJK.