# 3. How short-run profit or losses induce entry or exitFantastique Bikes is a company that manufactures bikes in a monopolistically competitive market. The following graph shows Fantastique's demandcurve, marginal revenue curve (MR), marginal cost curve (MC), and average total cost curve (ATC).Place the black point (plus symbol) on the graph to indicate the short-run profit-maximizing price and quantity for this monopolistically competitivecompany. Then, use the green rectangle (triangle symbols) to shade the area representing the company's profit or loss.500450Monopolistically Competitive Outcome400350Profit or Loss300250ATC200150100MC50MRDemand00100150200250300350400450500QUANTITY (Bikes)Given the profit-maximizing choice of output and price, the shop is making negativeprofit, which means there arefewershops in the industry relative to the long-run equilibrium.PRICE (Dollars per bike)50 Show the possible effect of this free entry and exit by shifting the demand curve for a typical individual producer of bikes on the following graph.DemandDemandQUANTITY (Bikes)Which of the following statements are true about both monopolistic competition and monopolies? Check all that apply.Firms can earn positive profit in the long runPrice equals average total cost in the long run.Price is above marginal cost.PRICE (Dollars per bike)

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Step 1

The demand curve, marginal revenue curve as well as the marginal and average cost curves of the firm is given in the figure. The monopolistically competitive firm maximizes its profit at the point where the marginal revenue equals the marginal cost. This is the profit maximizing output of the monopolistically competitive firm. The MR equals MC for the firm at the point of 200 bikes. This profit maximizing quantity when extended to intersect with the demand curve gives the profit maximizing price of the firm which is obtained at the price of \$300. From the diagram, the average total cost of producing a bike is intersecting the profit maximizing output at the price of \$225. Thus, the profit of the firm is found to be \$75 per unit of bike sold. Thus, it can be illustrated as follows:

Step 2

From the profit maximizing point of the firm, it is identified that there is an economic profit of \$75 per bike sold by the firm. the presence of the economic profit in the short run indicates that there will be fewer competitors in the market compared to the long run equilibrium because, under the long run, more new firms would enter into the market leading to the increased supply and eliminating the presence of economic profit. Thus, the firm earns positive economic profit which means there are fewer shops in the industry relative to the long run equilibrium.

Step 3

In the long run, the presence of the economic profit for a typical firm attracts the new firms into the market. This increases the number of competitors in the market. When the number of the competitors increases, the demand for the typical firm would decline ...

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