Microeconomics · Hard · 30 marks
EO past paper: International Final, Part A
Section I (30 points). A firm operates in a monopolistically competitive market. On the paper, each part gives a blank pair of axes (unlabelled, with no curves) for your graph.
(a) In the graph, construct a model of a firm in monopolistic competition. In your graph, use the demand curve (D), marginal revenue curve (MR), and marginal cost curve (MC). Mark the firm's optimal quantity as Q1 and the optimal price as P1. (Type your answer: describe the diagram in words, naming the axes, curves, shifts and areas.) [10] marks (b) Suppose that the demand for this firm's product increases from D1 to D2. Indicate this change in your graph and mark the new optimal quantity as Q2 and the new optimal price as P2, as well as the previous optimum Q1 and P1. (Type your answer: describe the diagram in words, naming the axes, curves, shifts and areas.) [10] marks (c) Consider that due to the existence of menu costs, the firm decides not to change its price after the increase in demand from D1 to D2 and keeps it at the original level P1. In your graph, show the quantity Q3 that the firm will sell in this case, as well as the previous quantities Q1 and Q2. (Type your answer: describe the diagram in words, naming the axes, curves, shifts and areas.)
Let π1 denote the profit in the first case when producing Q1, π2 denote the profit in the second case when producing Q2, and π3 denote the profit in the third case when producing Q3. Order these profits by size and explain this order. [10] marks
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