Which of the following statements is true about monopolistically competitive firms?
A) Unlike perfectly competitive firms, monopolistically competitive firms are able to raise their prices without losing all of their customers.
B) Like perfectly competitive firms, monopolistically competitive firms are not able to raise prices without losing all of their customers because they face competition from firms selling similar products.
C) Like perfectly competitive firms, monopolistically competitive firms maximize their profits by settling price equal to marginal cost.
D) Unlike perfectly competitive firms, monopolistically competitive face perfectly inelastic demand curves.
The correct answer and explanation is :
The correct answer is:
A) Unlike perfectly competitive firms, monopolistically competitive firms are able to raise their prices without losing all of their customers.
Explanation:
Monopolistic competition is a market structure where many firms sell products that are similar but not identical. Each firm has some control over its pricing because of product differentiation. Unlike perfectly competitive firms, which sell identical products and are price takers, monopolistically competitive firms can charge slightly higher prices without losing all of their customers. This is because consumers may have preferences for specific brands, quality, location, or other differentiating factors.
In contrast, in a perfectly competitive market, firms sell identical products, and consumers can switch to other sellers instantly if one firm raises its price. Therefore, perfectly competitive firms face a perfectly elastic demand curve, meaning they must accept the market price.
However, monopolistically competitive firms face a downward-sloping demand curve. This means that while they can increase their prices without losing all customers, they may lose some customers to competitors offering similar but not identical products. This ability to set prices gives monopolistically competitive firms some degree of market power, though not as much as a monopoly.
Let’s evaluate the other options:
- B is incorrect because monopolistically competitive firms do face competition, but their products are differentiated, allowing them to raise prices slightly without losing all customers.
- C is incorrect because monopolistically competitive firms maximize profit where marginal revenue equals marginal cost, not where price equals marginal cost.
- D is incorrect because monopolistically competitive firms do not face a perfectly inelastic demand curve. Instead, their demand curve is downward-sloping, meaning they lose some customers if they raise prices.
Here is an image illustrating monopolistic competition, where multiple stores sell similar but differentiated products, each with unique branding and pricing. This visually represents the concept that firms in monopolistic competition have some pricing power but still face competition.