Monopolistic Competition: Competition among Many

1. Monopolistic Competition: Competition Among Many

1.2. Answer to Try It! Problem

As shown in Panel (a), higher wages would cause both MC and ATC to increase. The upward shift in MC from MC1 to MC2 would cause the profit-maximizing level of output (number of meals served per week, in this case) to fall from q1 to q2 and price to increase from P1 to P2. The increase in ATC from ATC1 to ATC2 would mean that some restaurants would be earning negative economic profits, as shown by the shaded area.

As shown in Panel (b), in the long run, as some restaurants close down, the demand curve faced by the typical remaining restaurant would shift to the right from D1 to D2. The demand curve shift leads to a corresponding shift in marginal revenue from MR1 to MR2. Price would increase further from P2 to P3, and output would increase to q3, above q2. In the new long-run equilibrium, restaurants would again be earning zero economic profit.