Question

Suppose you manage a local grocery store, and you learn that a very popular national grocery chain (Whole Foods or Walmart) is about to open a store just a few miles away. Use the model of monopolistic competition to analyze the impact of this new store on the quantity of output your store should produce (Q) and the price your store should charge (P). What will happen to your profits? Please show graphically and explain your reasoning in detail. For example, how and why do profits change? How can that be seen on the graph?

Answer 1

Answer: The answer is given below

Explanation:

The entry of a new firm will lead to the reduction in the demand for the existing firm, thereby reducing the output and price. Also, in the long run when the new firm enters the market, this will lead to the supernormal profits to be driven down. The firms are price makers, faced with a demand curve that is downward sloping. Because each firm makes a product that is unique, it can either charge a lower or higher price than its rivals.

As the new firms enter the market, the demand for the product of the existing firm becomes more elastic, the demand curve will shift to the left, which drives down the price. All the super-normal profits will be gone. So, change in the elasticity effects profits .

For the market shares constant innovation to be defended, proper marketing is required. The monopolistic competition is based only on product differentiation . When new variety and innovative products are launched, this may attract consumers which will lead to increase in demand and drive up the profits.