Question

Sangeeta Bishop Thread for week 3 question 3 Answer the following by replying to this message. 3. Why is it that firms can earn profits in the long run in monopoly and oligopoly but not in monopolistic competition and perfect competition? What can firms do in monopolistic competition or perfect competition to make the short run last as long as possible since they can only make profits in the short run? Have you observed any firms employ such tactics? Can you give some examples? The response to this question is due by Thursday, July 30th.

Answer 1

3.Monopolies and Oligopoly are able to earn economic profits in the long run because there are barriers to entry on the market. Monopolies can maintain super-normal profits in the long run. As with all firms, profits are maximised when MC = MR. In general, the level of profit depends upon the degree of competition in the market, which for a pure monopoly is zero.

The existence of economic profits in a particular industry attracts new firms to the industry in the long run. As new firms enter, the supply curve shifts to the right, price falls, and profits fall. Firms continue to enter the industry until economic profits fall to zero. In case of Perfect Competition and Monopolistically Competitive firms there is no barrier to entry. In the long run many firms attracted by supernormal profits enter the market and thus profit is reduced.

2.In case of Perfect Competition, there are large number of firms selling homogeneous products. The firms in Perfect Competition are called as Price Takers. The concept of Advertising seems to be illogical in Perfect Competition. Advertising doesn't benefit the firm but the whole industry for the product, because all the products are replaceable. In case of Monopoly, it is the single seller and Price maker with market power. Monopoly can advertise to inform the customers about the products but there is no need to do so. Monopoly generally use public relations and advertising to increase awareness of their products and to maintain a good relationship with their buyers.

1. The shutdown rule states that in the short run a firm should continue to operate if price exceeds average variable costs. Firms will produce as long as marginal revenue (MR) is greater than average total cost (ATC), even if it is less than the variable, or marginal cost (MC). If the revenue the firm is making is greater than the variable cost (R>VC) then the firm is covering it’s variable costs and there is additional revenue to partially or entirely cover the fixed costs. One the other hand, if the variable cost is greater than the revenue being made (VC>R) then the firm is not even covering production costs and it should be shutdown immediately.

In the long run a firm should atleast make normal profits to remain in the industry. The long-run decision is based on the relationship of the price P and long-run average costs LRAC. If P ≥ LRAC then the firm will not exit the industry. If P < LRAC, then the firm will exit the industry.