When a firm maximises its profit, which of the following is correct for firms in monopolistic competition and perfect competition?
A) P = ATC always for firms in both perfect competition and monopolistic competition.
B) P = MC for both types of firms.
C) P = MR = MC for firms in perfect competition, and P MR = MC for firms in monopolistic competition.
D) P MR = MC for firms in both perfect competition and monopolistic competition.
E) MR = MC for firms in perfect competition and MR MC for firms in monopolistic competition.

Question

When a firm maximises its profit, which of the following is correct for firms in monopolistic competition and perfect competition?
A) P = ATC always for firms in both perfect competition and monopolistic competition.
B) P = MC for both types of firms.
C) P = MR = MC for firms in perfect competition, and P > MR = MC for firms in monopolistic competition.
D) P > MR = MC for firms in both perfect competition and monopolistic competition.
E) MR = MC for firms in perfect competition and MR > MC for firms in monopolistic competition.

Quizplus · Accepted Answer

In perfect competition, firms are price takers and have no market power. Therefore, they must sell at the prevailing market price, which is equal to their marginal revenue (MR). In this case, the profit-maximising output level occurs where MR = MC, which also equals the minimum point of the average total cost curve (ATC). As a result, firms in perfect competition always produce at the efficient scale and earn zero economic profit in the long run.

In contrast, firms in monopolistic competition have some market power and can set their own prices. They face a downward-sloping demand curve and can charge a price above their marginal cost (MC) to maximise profit. However, the profit-maximising output level occurs where marginal revenue (MR) equals marginal cost (MC), not where price equals MC. This is because the firm's pricing decision affects its total revenue and not just the revenue from the last unit sold. As a result, the price charged will be higher than the marginal cost, leading to a markup over the efficient level of output. Therefore, in monopolistic competition, P > MR = MC.

Option A is not correct because firms in monopolistic competition do not necessarily produce at the minimum ATC, as they have some market power.

Option B is not correct for the same reason as Option A.

Option D is not correct because firms in perfect competition earn zero economic profit in the long run, whereas firms in monopolistic competition can earn positive economic profit in the long run.

Option E is not correct because firms in monopolistic competition do not necessarily have MR > MC; their profit-maximising output level occurs where MR = MC.

When a Firm Maximises Its Profit, Which of the Following