Which of the following statements is correct?
A) Firms in monopolistic competition and monopoly can earn economic profits in both the short run and the long run.
B) Both perfectly competitive and monopolistically competitive firms produce the socially efficient level of output.
C) Firms in perfect competition, monopolistic competition, and monopoly maximize profits by producing where marginal revenue equals marginal cost.
D) Both perfectly competitive and monopolistically competitive firms charge a price equal to marginal cost.
The correct answer and explanation is:
The correct answer is C) Firms in perfect competition, monopolistic competition, and monopoly maximize profits by producing where marginal revenue equals marginal cost.
Explanation:
- Perfect Competition: In a perfectly competitive market, firms are price takers, meaning they cannot influence the market price. The firm maximizes its profit by producing at the point where marginal revenue (MR) equals marginal cost (MC). This ensures that the firm is producing at the most efficient output level, where any additional unit produced would cost more than it earns, reducing profit.
- Monopolistic Competition: In monopolistic competition, firms sell differentiated products and have some degree of market power. Just like in perfect competition, firms in monopolistic competition maximize profit by setting MR = MC. However, unlike perfect competition, monopolistically competitive firms do not produce at the socially efficient level in the long run because they charge a price higher than marginal cost due to product differentiation.
- Monopoly: A monopolist, being the sole producer in the market, also maximizes profit by producing where MR = MC. However, the monopolist’s price is typically above the marginal cost because it has the power to set prices higher than in competitive markets, leading to allocative inefficiency. The monopolist’s pricing is influenced by its market power and ability to restrict output.
Why the Other Options Are Incorrect:
- A) Firms in monopolistic competition and monopoly cannot earn economic profits in the long run. In monopolistic competition, entry of new firms leads to zero economic profits in the long run. In a monopoly, while it can earn economic profits in the long run, it does not guarantee this for both market structures.
- B) Only perfectly competitive firms produce the socially efficient level of output, where price equals marginal cost. Monopolistic competition and monopoly lead to deadweight loss due to higher prices.
- D) Only perfectly competitive firms charge a price equal to marginal cost in the long run. In monopolistic competition and monopoly, prices exceed marginal cost.
Thus, C is the correct answer because profit maximization across all market types involves setting MR = MC.