Monopolistic Competition worksheet
The answer key prints on its own page, so hand out everything before it.
Monopolistic Competition: practice worksheet
1. In the long run, a monopolistically competitive firm earns zero economic profit because:
- (A) The government regulates prices to equal average total cost
- (B) Free entry and exit shift the firm's demand curve until P = ATC
- (C) Firms collude to set prices equal to marginal cost
- (D) Consumers become indifferent between products over time
2. Excess capacity in monopolistic competition means the firm:
- (A) Produces more output than the socially optimal level
- (B) Operates on the upward-sloping portion of its ATC curve
- (C) Produces less than the quantity that minimizes average total cost
- (D) Has marginal cost equal to average total cost at its chosen output
3. Which of the following best distinguishes monopolistic competition from perfect competition?
- (A) Monopolistically competitive firms earn long-run economic profit
- (B) Monopolistically competitive firms sell differentiated products
- (C) Perfect competition has barriers to entry
- (D) Perfect competition features downward-sloping firm demand curves
4. A monopolistically competitive firm maximizes profit by producing where:
- (A) Price equals marginal cost
- (B) Price equals average total cost
- (C) Marginal revenue equals marginal cost
- (D) Marginal revenue equals average total cost
5. In the short run, a monopolistically competitive firm can earn positive economic profit. What happens next?
- (A) The government imposes a price ceiling to eliminate the profit
- (B) New firms enter, shifting each existing firm's demand curve to the left
- (C) Existing firms raise prices to increase their profit further
- (D) Consumers switch to perfectly competitive substitutes
6. In long-run equilibrium, the demand curve of a monopolistically competitive firm is tangent to:
- (A) The marginal cost curve
- (B) The marginal revenue curve
- (C) The average total cost curve
- (D) The average variable cost curve
7. Compared to a perfectly competitive firm in long-run equilibrium, a monopolistically competitive firm charges a price that is:
- (A) Lower, because there are more firms in the market
- (B) Equal, because both earn zero economic profit
- (C) Higher, because the firm has some market power from product differentiation
- (D) Higher, because the firm faces barriers to entry
8. A monopolistically competitive firm advertises heavily to differentiate its product. If successful, this advertising will:
- (A) Make the firm's demand curve more elastic (flatter)
- (B) Shift the firm's demand curve to the right and make it less elastic
- (C) Eliminate excess capacity by moving production to minimum ATC
- (D) Convert the market structure to perfect competition
9. A monopolistically competitive firm is currently earning short-run economic profit. In the long run, the firm's demand curve will shift to the left. This leftward shift stops when:
- (A) Price equals marginal cost at the profit-maximizing quantity
- (B) The demand curve is tangent to the ATC curve, making economic profit zero
- (C) Marginal revenue equals average total cost
- (D) The firm's demand curve becomes perfectly elastic
10. Excess capacity in monopolistic competition exists because in long-run equilibrium, the firm produces:
- (A) On the upward-sloping portion of ATC, beyond minimum ATC
- (B) At the minimum point of the ATC curve where P = MC
- (C) On the downward-sloping portion of ATC, to the left of minimum ATC
- (D) Where marginal cost intersects the demand curve
Monopolistic Competition: answer key
1. (B) Free entry does the work. New firms enter whenever profit exists, stealing customers from incumbents. Each firm's demand curve slides left until it's tangent to ATC, so P = ATC and profit is gone. No government regulation or collusion involved. (D) is wrong because products remain differentiated even in the long run; consumers still prefer one brand over another.
2. (C) Look at the ATC curve on the graph. The firm operates on the downward-sloping portion, to the left of the minimum point. It could lower average cost by producing more, but MR = MC doesn't call for that higher output level. (B) places the firm on the wrong side of the curve. (D) describes the minimum-ATC point itself, which is precisely where the firm does not produce.
3. (B) Product differentiation. That's the defining split. Both structures have free entry and zero long-run profit, so (A) is wrong. Perfect competition has no barriers to entry, so (C) has it backward. In perfect competition, firm demand is horizontal, not downward-sloping, so (D) is also backward.
4. (C) MR = MC. Same profit-maximization rule as any firm with market power: find that intersection on the graph, then read up to the demand curve for price. (A) is the perfect competition result. (B) is the zero-profit condition in long-run equilibrium, a result, not a decision rule. (D) has no economic significance in any market structure.
5. (B) No barriers to entry. Profit attracts new firms offering similar products, pulling customers away from incumbents. Each existing firm's demand shifts left until profit reaches zero. (C) is irrational because raising prices when new competitors are arriving would accelerate customer loss. (D) confuses market structures; consumers don't jump between structures, new firms enter the same monopolistically competitive market.
6. (C) Tangent to ATC. That single tangency point is where P = ATC and economic profit hits zero. If demand intersected ATC at two points, the firm could earn profit between them, so it must be tangency, not intersection. (A) would mean P = MC, which is the perfect competition outcome. (D) has no role in the long-run equilibrium condition.
7. (C) Product differentiation gives each firm a downward-sloping demand curve, so P > MC. The markup means a higher price than a perfectly competitive firm would charge. (B) confuses profit with price. Zero profit doesn't mean identical prices across market structures. (D) is wrong because monopolistic competition has no barriers to entry; the higher price comes from differentiation, not protection from competition.
8. (B) Successful advertising builds brand loyalty. More customers arrive (demand shifts right) and existing customers become less price-sensitive (demand steepens, becoming less elastic). Short-run profit rises temporarily. (A) gets the elasticity direction wrong because loyalty reduces sensitivity to price, it doesn't increase it. (C) misunderstands the model; excess capacity is structural and advertising doesn't eliminate it. (D) is the opposite of what happens because stronger differentiation moves further from perfect competition.
9. (B) Entry stops when there's no more profit to chase. That happens at the exact moment the demand curve becomes tangent to ATC, giving one touching point where P = ATC and economic profit is zero. (A) describes perfect competition (P = MC), which this market structure never reaches because the demand curve stays downward-sloping. (D) would mean the product is no longer differentiated at all, contradicting the foundational assumption of the model.
10. (C) The tangency between demand and ATC occurs on the downward-sloping portion, to the left of minimum ATC. The firm could theoretically lower average cost by producing more, but pushing output higher would drop price below ATC and generate losses. That gap between actual output and minimum-ATC output is the excess capacity you can see on the graph. (A) places the firm on the wrong side. (B) describes perfect competition's long-run equilibrium.