Question

How does a monopolistic competitor choose its profit-maximizing quantity of output and price?

Short answer

A monopolistic competitor chooses its profit-maximizing quantity of output and price by equating its marginal cost (MC) to marginal revenue (MR). This is done by finding the first derivatives of the cost and revenue functions, setting them equal to each other, and solving for the quantity of output (Q). To find the corresponding price, plug the profit-maximizing quantity into the demand curve function, which provides the price (P) that maximizes the firm's profit.

Step-by-step solution

Understand the key concepts

The first step is to understand the key concepts of marginal cost (MC) and marginal revenue (MR) in the context of a monopolistic competitor. - Marginal Cost (MC) is the additional cost incurred to produce one more unit of output. - Marginal Revenue (MR) is the additional revenue gained from selling one more unit of output. A monopolistic competitor will maximize its profits by choosing the quantity of output where the marginal cost (MC) equals marginal revenue (MR).

Determine the Marginal Cost (MC) curve

To find the profit-maximizing output, we first need to determine the marginal cost (MC) curve for the monopolistic competitor. This curve is typically obtained from the firm's cost function, which shows the total cost of producing a certain quantity of output. To derive the MC curve, find the first derivative of the cost function concerning the quantity produced.

Determine the Marginal Revenue (MR) curve

Next, we need to establish the monopolistic competitor's marginal revenue (MR) curve. This curve depends on the firm's demand curve, which shows the relationship between the price and quantity demanded of the good or service provided. To derive the MR curve, find the first derivative of the revenue function concerning the quantity produced.

Find the profit-maximizing quantity of output

Now that we have the MC and MR curves, we can find the profit-maximizing quantity of output by equating the two curves: \(MC(Q) = MR(Q)\) Where \(Q\) represents the quantity of output produced. Solve this equation for \(Q\) to find the optimal quantity that maximizes the firm's profit.

Calculate the profit-maximizing price

After determining the profit-maximizing quantity of output, we need to find the price corresponding to that level of output. To do this, plug the profit-maximizing quantity (Q) into the firm's demand curve, which gives the price (P) at which the good or service can be sold: \(P = D(Q)\) Where \(D(Q)\) is the demand curve function. In conclusion, a monopolistic competitor can choose its profit-maximizing quantity of output and price by equating marginal cost and marginal revenue, and then using the demand curve to find the corresponding price for the determined quantity of output.