Question

Draw the relevant curves to show a monopolistic competitor suffering a loss in the short run. What will this firm do in the long run if the situation does not improve? (Assume its \(A T C\) and \(M C\) curves don't change in the long run. How would this action affect other firms in this market?

Short answer

On suffering a loss in the short run, a monopolistic firm whose ATC and MC curves don't change in the long run, would likely exit from the market to curb continued losses. This exit could increase the product prices due to reduced supply, potentially flipping the loss into profit for remaining market players.

Step-by-step solution

Define and Draw Initial Curves

To start with, plot a graph with Quantity (Q) on x-axis and Price/Cost (P/C) on y-axis. Draw the downward-sloping Demand curve (D) and Marginal Revenue (MR) curve. The MR curve lies below the demand curve in monopolistic competition. Further, plot the U-shaped Average Total Cost (ATC) curve and the Marginal Cost (MC) curve which intersects ATC at its minimum point.

Identify Loss in Short Run

Given that the firm is suffering loss in the short run, it means that Price is less than Average Total Cost i.e., P < ATC. Draw a horizontal line corresponding to the price where MR=MC. The point where this line intersects the ATC curve represents loss per unit (ATC-P). The loss rectangle is depicted by this loss-per-unit height and the quantity sold (on the x-axis) width.

Actions in Long Run

In the long run, if the firm is still suffering losses, it has the potential to exit the market. This is a logical step for the firm to avoid sustained and possibly, escalated losses.

Impact on Other Firms

When firms exit, it reduces the overall industry supply which increases the product prices. This leads to greater demand for remaining firms, and in case their ATC and MC curves don't change, it is likely to convert their losses into profits by selling the product at higher market price hence improving their profitability.