SOLUTIONS TO SELF-CHECK QUESTIONS

9.1 Monopolistic Competition

1. Using the three-step method, an increase in demand will manifest itself as a rightward shift in the demand curve, and a rightward shift in marginal revenue. The shift in marginal revenue will cause a movement up the marginal cost curve to the new intersection between MR and MC at a higher level of output. The new price can be read by drawing a line up from the new output level to the new demand curve, and then over to the vertical axis. The new price should be higher. The increase in quantity will cause a movement along the average cost curve to a possibly higher level of average cost. The price, though, will increase more, causing an increase in total profits.
2. As long as the original firm is earning positive economic profits, other firms will respond in ways that take away the original firm’s profits. This will manifest itself as a decrease in demand for the original firm’s product, essentially unwinding the process described in the answer to question 1. In the long-run equilibrium, all firms in monopolistically competitive markets will earn zero economic profits.

9.2 Oligopoly

1. Firms will generally act more like competitors because, although their products are somewhat different, there are still plenty of substitutes for consumers to choose if prices get too high.
2. Each individual benefits more from pursuing self-interest, because the self-interested option is better for him regardless of what the other participant does.