Question

Suppose that, due to a successful advertising campaign, a monopolistic competitor experiences an increase in demand for its product. How will that affect the price it charges and the quantity it supplies?

Short answer

In a monopolistic competition, an increase in demand due to a successful advertising campaign will result in a rightward shift of the demand curve and the marginal revenue curve. This leads to a new equilibrium point where the marginal cost (MC) and the new marginal revenue (MR) curves intersect. Consequently, the monopolistic competitor will increase both the price charged and the quantity supplied to maximize profit.

Step-by-step solution

Understand Monopolistic Competition

Monopolistic competition is a market structure characterized by a large number of firms producing differentiated products. Each firm has some degree of market power, allowing them to set their prices above marginal cost. However, due to the presence of competitor firms, they do not have full control over price.

Identify the Initial Equilibrium

Initially, the monopolistic competitor's price and quantity are determined where its marginal cost (MC) curve intersects with its marginal revenue (MR) curve. At this point, the firm maximizes its profit. To find the price charged, we look at the point on the firm's demand curve at the corresponding output level.

Analyze the Effect of an Increase in Demand

An increase in demand shifts the demand curve of the monopolistic competitor to the right. As a result, the firm's marginal revenue (MR) curve also shifts to the right.

Establish the New Equilibrium

After an increase in demand, the monopolistic competitor's new equilibrium is established where the new marginal revenue (MR) curve intersects with the marginal cost (MC) curve. This intersection represents the new profit-maximizing output level.

Determine the New Price and Quantity

By finding the point on the new demand curve corresponding to the new equilibrium output level, we can determine the new price. Hence, the price charged by the monopolistic competitor increases. Similarly, the new equilibrium output level is higher than before, meaning that the quantity supplied also increases. In conclusion, due to a successful advertising campaign, a monopolistic competitor will experience an increase in demand, which will lead to a higher price and an increase in the quantity supplied.