Given
A coffee shop sits in a monopolistically competitive market (lots of cafes, each slightly different). Its demand, revenue, and cost curves are given below.
Demand: P = 24 − QMR = 24 − 2QTC = 50 + Q²MC = 2Q
Question a
Find the profit-maximizing quantity, price, and profit for this coffee shop in the short run.
Hint
Same three-step recipe you used for monopoly. (1) Set MR = MC and solve for Q. (2) Plug Q into the demand curve to get P. (3) Profit = TR − TC = P Q − (50 + Q²).
Short Answer — Long-Run Equilibrium (N-Firm Market)
Given
A monopolistically competitive market has N identical firms. The demand curve facing each firm (which depends on how many competitors there are) and each firm's costs are:
As more firms enter, each firm's demand curve shifts left (each firm serves fewer customers). Entry continues until each firm earns zero economic profit — the long-run equilibrium.
Question b
In the long run, how many firms N will be in this market? What quantity does each firm produce, and what price does each firm charge?
Hint
Two conditions must hold at once in long-run equilibrium: (i) MR = MC (profit-max for each firm) and (ii) P = ATC (zero profit from entry). Step 1: use MR = MC to get Q as a function of N. Step 2: compute P from demand and ATC from TC/Q, and set them equal to solve for N. Step 3: plug N back to get numeric Q and P.
Step 2 — P = ATC:
P from demand: P = 100/N − Q = 100/N − 25/N = 75/N.
ATC = TC/Q = (50 + Q²)/Q = 50/Q + Q = 50/(25/N) + 25/N = 2N + 25/N.
Set P = ATC: 75/N = 2N + 25/N → 50/N = 2N → N² = 25 → N = 5.
Step 3 — plug N = 5 back in:
Q = 25/5 = 5.
P = 75/5 = $15.
Sanity check: ATC at Q = 5 is 50/5 + 5 = 15 = P ✓. Profit = (P − ATC) × Q = 0 ✓. MC at Q = 5 is 10, so P = 15 > MC = 10 — the markup persists even in long-run equilibrium.
Part 3
Refer to Figure 16-2
Figure 16-2
A monopolistically competitive firm faces the demand, MR, MC, and ATC curves shown below. Use the figure to answer the next three questions. (Demand is linear: P = 100 − Q.)
Figure 16-2. A monopolistically competitive firm with a downward-sloping demand curve and U-shaped cost curves.
Question 1 — Refer to Figure 16-2
What price will the monopolistically competitive firm charge in this market?
Hint
Step 1: find Q where MR = MC. Step 2: read the price straight up on the demand curve (not MR) at that Q.
ExplanationAnswer: $70. MR crosses MC at Q = 30. Going straight up from Q = 30 to the demand curve gives P = 100 − 30 = $70. (If you read the price off MR instead, you'd get $40 — that's the trap answer.)
Question 2 — Refer to Figure 16-2
How much consumer surplus will be derived from the purchase of this product at the monopolistically competitive price?
Hint
Consumer surplus is the triangle above the price and below the demand curve, from Q = 0 to the quantity actually sold. Area of a triangle = ½ × base × height. Base = Q sold. Height = (demand intercept) − (price).
ExplanationAnswer: $450. At P = $70 and Q = 30 (from Question 1), consumer surplus is the triangle with base 30 and height (100 − 70) = 30.
CS = ½ × 30 × 30 = $450.
$2,100 is the firm's revenue (70 × 30), $1,350 is the rectangle below price down to zero, and $900 is a different wrong area — classic distractors.
Question 3 — Refer to Figure 16-2
How much profit will the monopolistically competitive firm earn in this situation?
Hint
Profit is a rectangle: height is (P − ATC) at the profit-max Q, width is the Q. Read ATC straight up from Q = 30 on the ATC curve.
ExplanationAnswer: $600. At Q = 30, P = $70 (from demand) and ATC = $50 (from the ATC curve).
Profit = (P − ATC) × Q = (70 − 50) × 30 = $600.
Since profit is positive, this is a short-run picture — in the long run, entry would drive profit toward zero. $0 is the long-run answer (wrong for this short-run snapshot); $2,100 is total revenue, not profit.
Part 4
Multiple Choice — Concepts
Question 4
For a monopolistically competitive firm,
Hint
Every profit-maximizing firm — monopoly, perfect competition, oligopoly, monopolistic competition — uses the same rule: produce where MR = MC. The differences between market structures show up in the price, not in the rule.
ExplanationAnswer: B. All profit-maximizing firms produce where MR = MC. For a monopolistically competitive firm, MR < P because demand slopes down (so A is wrong). P > MC because of the markup (so C is wrong). And in long-run equilibrium, P = ATC at the tangency quantity, which is on the downward-sloping part of ATC, not the minimum (so D is wrong).
Question 5
Monopolistic competition is considered inefficient because
Hint
Efficiency means every unit whose value to consumers exceeds its marginal cost gets produced. Monopolistic competition violates which of those conditions?
ExplanationAnswer: A. Because P > MC in monopolistic competition, some consumers who would value an extra unit above its marginal cost won't buy it (the price is too high for them). Those mutually beneficial trades never happen — that's the standard deadweight loss from the markup. Long-run profits are actually zero (so C is wrong), there are no barriers to entry (D), and output is too low rather than excessive (B).
Question 6
Which of the following statements is TRUE about the long-run equilibrium of a monopolistically competitive market?
Hint
Two forces operate in long-run equilibrium. The monopoly side (downward-sloping demand) keeps P above one thing. The competition side (free entry) drives profit to zero, which means P equals something else.
ExplanationAnswer: C. Like a monopoly: demand slopes down, so MR < P, and profit maximization at MR = MC gives P > MC. Like perfect competition: free entry and exit drive profit to zero, which means P = ATC. The tangency between demand and ATC is what makes this possible simultaneously. Option B is the perfectly competitive outcome (where P also equals minimum ATC).
Question 7
"Excess capacity" in a monopolistically competitive market means that
Hint
Look at the long-run diagram: the tangency of demand to ATC is on the downward-sloping portion of ATC, not at the bottom. What does that tell you about the firm's quantity compared to the quantity that minimizes ATC?
ExplanationAnswer: B. Because demand is tangent to ATC on its downward-sloping portion, the firm's quantity is strictly less than the quantity that minimizes ATC (the "efficient scale"). If the firm produced more, its ATC would be lower — the firm has capacity it is not using. It doesn't increase output because doing so would require cutting the price on every unit. The zero-profit condition in (D) is also true in the long run, but that's not what "excess capacity" means.
Part 5
True or False
Question 8
Monopolistic competition is characterized by a few sellers offering similar products, whereas oligopoly is characterized by many sellers offering differentiated products.
Hint
Read carefully. Monopolistic competition has many firms. Oligopoly has few firms. The statement flips the two.
ExplanationFalse. The definitions are reversed. Monopolistic competition is many firms selling differentiated products. Oligopoly is a few firms, usually selling similar or identical products. The Figure 1 decision tree in Mankiw: first ask "how many firms?" — then, if many, ask "differentiated or not?"
Question 9
Policymakers have generally come to accept the view that advertising enhances the efficiency of markets.
Hint
Think about the eyeglass study: states that allowed optometrist advertising had prices more than 20% lower than states that banned it. What did that evidence push policymakers toward?
ExplanationTrue. Benham's eyeglass study (1972) and the Rhode Island liquor study (1999) both showed that allowing advertising lowered prices by giving consumers more information and making markets more competitive. Over time, courts have struck down most professional advertising bans (for lawyers, doctors, pharmacists) on exactly these grounds. Mankiw summarizes it as: "In many markets, advertising fosters competition and leads to lower prices for consumers."
Question 10
When a monopolistically competitive firm is in long-run equilibrium, the values of marginal cost, average total cost, and price are all the same.
Hint
In long-run equilibrium, free entry drives profit to zero, so P = ATC. But is MC also equal to ATC at that point? Look at the tangency diagram: is the tangency at the minimum of ATC?
ExplanationFalse. Long-run equilibrium requires P = ATC (zero profit) and MR = MC (profit max), but NOT P = MC. Because the tangency of demand and ATC is on the downward-sloping part of ATC, marginal cost is strictly below ATC at that point (remember: MC < ATC whenever ATC is falling). And MR < P because demand slopes down. So MC < ATC = P — three different levels. (Only perfect competition has MC = ATC = P at long-run equilibrium, because PC firms land at the minimum of ATC where MC crosses ATC.)
Question 11
Monopolistically competitive firms, like monopoly firms, maximize their profits by charging a price that exceeds marginal cost.
Hint
A monopolistically competitive firm faces a downward-sloping demand curve. That means MR < P. Profit-max sets MR = MC. Put those together — where does P land relative to MC?
ExplanationTrue. Since demand slopes down, MR < P. Profit maximization gives MR = MC. Putting these together: P > MR = MC, so P > MC. This markup persists even in the long run, which is exactly why monopolistic competition isn't fully efficient — consumers who would pay more than MC (but less than P) don't buy, leaving some gains from trade unrealized.
Question 12
In the long run, a monopolistically competitive firm produces at the quantity that minimizes its average total cost.
Hint
The quantity that minimizes ATC is the "efficient scale." Does a monopolistically competitive firm produce at that quantity, or below it?
ExplanationFalse. This is the definition of excess capacity: because demand is tangent to ATC on its downward-sloping part, the monopolistically competitive firm produces below the quantity that minimizes ATC. Perfectly competitive firms are the ones that produce at minimum ATC in the long run.
Question 13
When a firm spends a lot of money on a flashy ad that contains no real information about price or quality, consumers learn nothing from seeing the ad.
Hint
Mankiw's signaling story: what is the firm demonstrating when it spends a lot of money on an ad, even if the content is empty?
ExplanationFalse. Even a content-free ad transmits information: the willingness to spend money is itself a signal that the firm expects the product to sell well enough to recoup the ad spend. A firm with a bad product wouldn't burn cash on ads, because they wouldn't earn enough repeat business to pay for them. The Kellogg-vs-General Mills cereal example in Mankiw: Kellogg advertises precisely because it knows its product is good.