Question

(a) Why does a typical monopolistically competitive firm face a downward-sloping demand curve and explain with good examples?
[3 marks]

(b) What is meant by the term "excess capacity" as it relates to monopolistically competitive firms and explain with good examples?
[7 marks]

Answer 1

In under monopolistic competition the firm sells near substitute products and maximize their profit when are producing at a level where its marginal revenue equals its marginal costs. As firms differentiated nature of products which are not perfect substitutes for each other thus provides the firm some ability to set its own price which means the firms will charge a price that exceeds it's marginal costs; and as result demand curve for a firm in typical monopolistically competitive market is downward-sloping. The market power causes the firms to face a downward sloping demand curve.

For example: Cereals have a many varieties of different brands (example Lucky Charms, Apple Jacks, Cap’n Crunch). Almost majority of them probably taste slightly different and thus firm some ability to set its own price. Thus the individual firm's demand curve is downward sloping depicting market power