Question

Consider a monopolistically competitive firm whose cost is given by C = 2 + 2Q + Q², and its demand function is given by

Q =32 – 4P.  

(1) Find the optimal price and quantity of output in the short run.

(2) What long-run adjustments should you expect?   Explain.

Answer 1

Monopolistically competitive firm maximises profit where MR = MC:

MC = dC/dQ = 2 + 2Q

MR = d(P.Q)/dQ = 8 - Q/2

2 + 2Q = 8 - Q/2

Q = 2.4 (optimal output)

P = 7.4 (optimal price)

Profit = P x Q - C = 2.4 x 7.4 - 2 - 2 x 2.4 - 2.42

Profit = 5.2

2) In the long run a Monopolistically competitive firm should earn zero profit, more firms would enter the market seeking profits.

Therefore, demand facing a Monopolistically competitive firm would decrease (shift left) and long term profit would become zero.