Maximizing profits in a monopolistically competitive model
I'm confused on a concept and I have a test coming up, so I need a bit of help on a discussion I had in class today about profit maximization I don't fully understand...
Given a situation (discussed in class today) in a monopolistically competitive market (NOT a monopoly), if my price is $10 for an item and at my present rate of output, my marginal cost is $8 per unit (and rising)... Do I need to change my price to maximize my profits? With a rising marginal cost, I don't think my profits are maximized, but I'm not sure how to tell for sure, and I'm trying to figure out in a monopolistically competitive model whether I should drop the price to lure more customers (to increase profits), raise the price to get more revenue per sale (but make fewer sales), or leave it alone. With rising marginal costs, it makes sense (in my mind) that I'm not currently maximizing. We talked about it today in class, but I didn't get the full concept... and the test is tomorrow morning. PLEASE HELP!!!
I suppose the actual scenario that I need to understand is this: Given a price and marginal cost (for example the $10 and $8 respectively above), am I maximizing profits already, or do I need to change my price... and why?
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Solution Preview
First, let's look at a brief explanation of the Monopolistic Competition market:
Monopolistic competition satisfies the following conditions:
- like perfect competition in that there is a large number of sellers so that the actions of one producer have no significant effect on rivals;
- like monopoly and oligopoly in that each seller faces a negatively sloped demand curve for a 'distinctive' product; and,
- each seller possesses some market power depending on the elasticity of demand.
Under monopolistic competition, independence of producers results from the 'attachment' of certain consumers to specific producers. This affects price but to a lesser extent than under monopoly. In the long-run, price equals average costs but marginal revenue equals marginal cost. In theory monopolistic competition is considered inefficient because price is higher and quantity supplied lower than under perfect competition.
Monopolistic competition occurs in a market in which product differentiation exists and which exhibits elements of both perfect competition and monopoly. There are a large number of sellers of close substitutes that are not ...