When a firm exits a monopolistically competitive market, the individual demand curves faced by all existing firms in that market will
a. shift in a direction that is unpredictable without further information.
b. shift to the right.
c. shift to the left.
d. remain unchanged; only the supply curve will shift.
The correct answer and explanation is :
The correct answer is b. shift to the right.
Explanation:
Monopolistic competition is a market structure characterized by many firms selling products that are differentiated from one another. In the short run, firms in monopolistic competition can earn profits, but in the long run, these profits attract new firms to enter the market. However, when firms exit the market, the remaining firms experience changes in demand.
Here’s how the process works:
- Exiting Firms: When a firm exits a monopolistically competitive market, it reduces the total number of firms in that market. This reduction leads to a decrease in the overall supply of the differentiated products available to consumers.
- Impact on Demand: With fewer firms in the market, the remaining firms now have a larger share of the market. The demand curve faced by each of the remaining firms will shift to the right because the exiting firms’ customers will now shift their demand to the products of the firms that are still in the market. In other words, the existing firms now have more customers to serve, increasing their individual demand.
- Long-Run Adjustment: In the long run, firms in a monopolistically competitive market will continue to enter or exit based on profitability. As firms exit and demand increases for the remaining firms, the market will eventually reach an equilibrium where firms earn zero economic profit. However, the key point here is that, immediately after a firm exits, the demand curve faced by each remaining firm shifts to the right due to the redistribution of consumers to the surviving firms.
Thus, the exit of a firm in monopolistic competition leads to a rightward shift in the demand curve faced by each of the remaining firms, reflecting the fact that they now have a larger share of the market.