Question

4. Chandra has a business that produces a good, where her total costs to produce Q units is described as

TC = 400 + .5Q2

The structure of the industry is monopolistically competitive. Currently she produces Q=20 per day and the elasticity of demand for her product is Ed= -2.0. What do you expect to happen to the demand for Chandra's product in the long run?

Answer 1

Consider the given problem here Chandra has a business having cost function, => TC = 400 + 0.5*Q^2, => MC = Q and the average cost (AC) = 400/Q + 0.5*Q. Currently she produces 20 units per day, the corresponding AC is.

=> AC = 400/Q + 0.5*Q = 400/20 + 0.5*20 = 20 + 10 = 30, => AC = $30.

=> MC = Q = 20.

The structure of the industry is monopolistically competitive, => the following condition should holds.

=> P*(1+1/e) = MC, where “e=elasticity of demand”.

=> P*(1-1/2) = 20, => P/2 = 20, => P = $40 > AC = $30.

So, currently Chandra is earning positive profit implied new firms will enter into the industry in the LR. So, as the new firm will enter Chandra will lose market share, => demand for Chandra’s product will decrease in the LR.