Suppose in the city of Smugsburg, DVD rental stores operate in a monopolistically competitive market. If the price of DVD rentals in Smugsburg is currently equal to $5 per tape and the average cost of renting videos is $1 per DVD, in the long run we expect the price of renting DVDs to

Question

Quizplus · Accepted Answer

In a monopolistically competitive market, firms can differentiate their products to some extent, but they still face competition from other firms. As a result, in the long run, firms in this market tend to earn only normal profits, where total revenue equals total costs (including both explicit and implicit costs). In this case, the current price of $5 per tape is likely higher than the minimum average cost of $1 per DVD, implying that firms are earning some economic profits in the short run. However, in the long run, new firms will enter the market to capture some of these profits, increasing competition and driving down prices. As a result, we expect the price of DVD rentals to decrease. However, the average cost of producing DVD rentals is likely to increase because as new firms enter the market, they will increase the demand for resources used in producing DVDs, driving up their prices. This increase in costs combined with the decrease in price leads us to choose option C.

Suppose in the City of Smugsburg, DVD Rental Stores Operate