Consider a small city's dry-cleaning market, which is monopolistically competitive. Currently, the typical dry-cleaner is charging $5 an item. The average cost of dry-cleaning is $2. The typical dry-cleaners clean 1,000 items per week. (Each customer drops off approximately 4 items).
Suppose, a new dry-cleaner was to enter the market, and explain what would happen to the price, average cost, output, and profit of a typical dry-cleaner.
Eventually, what is the long run equilibrium?
Solution Preview
Price = $5 an item
Average Cost of Dry Cleaning = $2
Margin = 5 - 2 = $3 per item
So the net profits per week will be 1000 X 3 = $3,000
As the new firm enters, the demand for existing firm will reduce with its marginal revenue. Thus the price that it charges will also reduce (remember MR=MC for profit ...
Solution Summary
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