Question

How is the perceived demand curve for a monopolistically competitive firm different from the perceived demand curve for a monopoly or a perfectly competitive firm?

Short answer

In summary, the perceived demand curves for monopolistically competitive, monopoly, and perfectly competitive firms differ due to market power and product differentiation. A monopolistically competitive firm has a downward sloping demand curve because of competition and product differentiation, while a monopoly also has a downward sloping demand curve but with more price-setting power due to no close substitutes. In contrast, the perfectly competitive firm has a horizontal demand curve as it has no price-setting power and there is no product differentiation.

Step-by-step solution

Understanding market structures and demand curves

In order to distinguish between the different demand curves, we need to understand the market structures of each type of firm. 1. Monopolistically Competitive Firm: In this market structure, there are many firms, each producing a slightly differentiated product. Due to product differentiation, firms have some price-setting power, but there is enough competition to limit their ability to raise prices. 2. Monopoly: In a monopoly market structure, there is only one firm producing a unique product with no close substitutes. Therefore, the firm has complete control over the market and has significant price-setting power. 3. Perfectly Competitive Firm: In a perfectly competitive market, there are many firms producing identical products. These firms have no price-setting power and are considered price-takers. The market price is determined by the intersection of the industry supply and demand curves.

Demand Curves for Different Market Structures

Now, let's discuss the demand curves for each type of firm: 1. Monopolistically Competitive Firm: The perceived demand curve for a monopolistically competitive firm is downward sloping. This is because the firm faces competition from other firms producing similar, but slightly differentiated products. As a result, if the firm raises its price, some consumers will switch to a substitute product from a competing firm. 2. Monopoly: The perceived demand curve for a monopoly is also downward sloping. However, it has a different shape compared to the monopolistically competitive firm's demand curve. Since there are no close substitutes in the market, the monopoly firm has more control over setting its price. The monopolist's demand curve represents the entire market demand, and the firm can choose to set prices and produce output where its marginal revenue equals marginal cost to maximize profit. 3. Perfectly Competitive Firm: For a perfectly competitive firm, the perceived demand curve is horizontal, meaning it's perfectly elastic. The firm has no control over the market price, as it's determined by the intersection of industry supply and demand curves. Since all firms in the market produce identical products and the firm is a price-taker, it can sell any quantity it produces at the market price, without affecting the price.

Comparing the Perceived Demand Curves

In summary, the difference between the perceived demand curves for a monopolistically competitive firm, a monopoly, and a perfectly competitive firm lie in the firms' market power and the degree of product differentiation: 1. For a Monopolistically Competitive Firm: Downward sloping curve due to competition and product differentiation. 2. For a Monopoly: Downward sloping curve, but with greater price-setting power due to no close substitutes. 3. For a Perfectly Competitive Firm: Horizontal curve since the firm has no price-setting power and there's no product differentiation.