Question

In the long run firms in monopolistically competitive markets operate O A. with excess capacity because they face downward-sloping demand curves. O B. at optimal capacity because they have perfectly elastic demand curves. O c. with excess capacity because they face perfectly elastic demand curves. D. at optimal capacity because they face downward-sloping demand curves.

Answer 1

In the long run,firms in monopolistically competitive markets operate

A. with excess capacity because they face downward- sloping demand curves.

(Monopolistic market is a market structure which is characterized with many sellers which sell similar but not identical products.The demand curve of a monopolistically competitive market is elastic,because even if the firms are selling differentiated products many of these products are close substitutes,so if one seller increases the price,customers easily switch to other sellers.The demand is not however perfectly elastic,because as compared to perfect competition,monopolistically competitive markets have fewer competitors and also the products are close substitutes for one another but not perfect substitutes.

A monopolistic competition can only increase the demand for its goods by lowering the price,as a result the marginal revenue is always less than the market price of the product.Thus a monopolistic competition has a downward sloping demand curve,where decrease in price increases the price.

A downward sloping demand curve is one of the most important reasons as to why a monoplistically competitive firm operates with excess capacity.

In monopolistic competition,there are many small firms,and each one of them is producing an output which is less than optimal,as the point of tangency of the average cost curve and the downward falling demand curve is always at the falling portion of the latter.As a result at the equilibrium every firm is producing at a cost which is higher than the minimum.When a firm produces at small quantity at a higher cost,it exhibits excess capacity,which is the difference between the optimal level of output at the minimum point of the average cost curve and the output actually attained at the equlibrium.Under monopolistic competition every firm has excess capacity in the long run.

Thus we can conclude that,In the long run,firms in monopolistically comeptitive markets operate with excess capacity because they face downward sloping demand curves.)