When a new firm enters a monopolistically competitive market, the individual demand curves faced by all existing firms in that market will
a. shift to the left.
b. shift to the right.
c. shift in a direction that is unpredictable without further information.
d. remain unchanged; only the supply curve will shift.
The correct answer and explanation is :
The correct answer is:
a. shift to the left.
Explanation:
In a monopolistically competitive market, many firms sell differentiated products that are close substitutes for each other. Each firm has some degree of market power, which means it can set its own prices but is still affected by the prices set by competitors. The demand curve faced by each firm is downward-sloping, reflecting that as the firm raises its price, it loses some customers to other firms offering similar products.
Now, consider what happens when a new firm enters this market. Since the products sold by firms in monopolistic competition are substitutes, the new firm will offer a product that competes with the existing firms’ products. As a result, consumers now have more options to choose from, meaning that the demand for each existing firm’s product will decrease.
This decrease in demand occurs because:
- Consumers now have more choices. With the introduction of the new firm’s product, consumers can shift their demand toward that product, reducing the demand faced by existing firms.
- The market becomes more competitive. As the total number of firms in the market increases, the share of the market that any one firm can capture decreases, leading to a leftward shift in the demand curve for existing firms.
In the short run, each firm faces a smaller market share and thus less demand for its product. As a result, the individual demand curves of existing firms shift leftward (i.e., they now represent lower quantities at each price level).
Long-Term Effects:
In the long run, firms may adjust by either exiting the market (if they cannot compete profitably) or by modifying their products to regain customers. However, in the short run immediately after a new firm enters, the direct effect is a leftward shift in the demand curve for the existing firms.