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    Maximizing Profits in a Monopolistic Competition Model

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    I think I'm understanding this better, but I still need some help. I had another BrainMass TA (101733) who was very helpful with concepts (thank you), but I want to cross-reference the response I received with another independent viewpoint...

    Here is a discussion point that was put to the class, and I'll transcribe it verbatim:

    "You are the manager of a firm operating in a monopolistic competition market situation. Currently, your price is $10. At the present rate of output your marginal cost is $8 per unit and rising. Are you currently maximizing your total profits? If you are trying to maximize profits, should you change your price? If so, what should you do- raise or lower the price? Explain."

    I'm now pretty clear on how monopolistic competition differs from the other three market structures of monopoly, perfect competition, and oligopoly. I have a test coming up today in which the concept above may be a topic, so I need to understand the concept better. It shouldn't take too much time to explain, since I don't think I need DETAILED conceptual explanations (like theory and characteristics of a monopolistically competitive firm, or the fact that profits are maximized when price is set where marginal revenues equal marginal costs, etc.) I understand in a monopolistically competetive model that one firms actions have little effect on other firms' price changes due to product differentiation and many buyers/sellers, etc.

    I need someone to check my thought process in the class discussion that we had today on the scenario above... Here's what I said in class earlier yesterday:

    I think, given the scenario above, that we're 1) not maximizing profits, 2) need to change our price, and 3) the price must be lowered to entice more consumers to purchase, realizing that lower price and rising marginal costs equal smaller profits but higher quantity sold, which in the short-run gives higher overall economic profit, but in a monopolistically competetive model, zero economic profit in the long-run as additional firms enter the market and increased product differentiation results in near perfect competition eventually.

    Am I thinking right? From the class discussion, the instructor seemed to be looking for definitive answers such as yes/no, change price/don't change price, and raise/lower/keep same. But after reading the earlier response from the OTA on the topic, conceptually there appears to be not enough information to draw any concrete conclusions. That kind of confused me, that we'd be asked a question in class that was conceptually able to be discussed, but quantifiably not be able to answer. Am I missing something? I'm looking for a sanity check... How should I have answered this question earlier yesterday?

    Now I'm wondering if it the question is a math problem (our book covers formulas and calculations of profit maximization) or a theory problem...

    How would you answer it???

    A quick turn around on this (with basics) is appreciated so I can build a little confidence going into the exam, in case I see something like this again... Otherwise I'll be second guessing myself all day. Thanks.

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    Solution Preview

    Now I know your question and would like to offer you further assistance.
    This is a Bertrand Game and here is the detailed explanation:

    (1) No, you are not maximizing your total profits. It's not because the marginal cost is increasing. It is because the current price is higher than your present marginal cost. If take the price as given and the market is competitive (a large number of rivals charging the same price), you can maximize your profit by producing at the output level where MC=P=10. And this is possible because your MC is still ...

    Solution Summary

    The expert examines maximizing profits in a monopolistic competition models. The discussion points are transcribes verbatim.