WAEC Economics 2013 Theory — Question 9

Model answer

(a) Characteristics of monopolistic competition: (i) There are many buyers and many sellers. (ii) Products are differentiated. (iii) There is free entry and free exit into/from the industry. (b) A monopolistically competitive firm can earn abnormal profit in the short run: this is represented by the rectangle formed where price (P) exceeds average cost (C) at the profit-maximizing output (where MC = MR). This excess profit attracts new firms into the industry (since entry is free), and the increased competition/supply shifts the firm's demand curve to the left until price equals average cost and there is no more excess (abnormal) profit — i.e. in the long run the firm makes only normal profit, where price equals long-run average cost (LRAC). [Diagram: short-run price/cost curves MC, ATC, AR(D), MR with a shaded abnormal-profit rectangle collapsing to zero profit as the demand curve shifts left in the long run.] (c) A natural monopoly is one that develops as a result of exclusive access by one firm to a resource or technique of production. A legal monopoly is one brought about by a special privilege or exclusive right given to a producer or inventor of a product, such as a patent right or copyright.