You are hired as the consultant to a monopolistically competitive firm. The firm reports the following information about its price, marginal cost, and average total cost. Can the firm possibly be maximizing profit? If not, what should it do to increase profit? If the firm is profit maximizing, is the firm in a long-run equilibrium? If not, what will happen to restore long-run equilibrium?

a. P ATC

b. P > MC, P < ATC

c. P = MC, P > ATC

d. P > MC, P = ATC

a. not maximizing profit, reduce output, not in long run equilibrium, new firms will enter till P=ATC

b. may or may not be maximizing profit, not in long run equilibrium, having loss in long run, firms will exit till P=ATC

c. The firm is not maximizing profit, can reduce output to increase profit, not in long run equilibrium, new firms enter till P=ATC

d. May or may not be maximizing profit, in long run equilibrium as P=ATC, no incentive to enter or exit, zero economic profits

Explanation:

For profit maximization the marginal revenue should be equal to marginal cost. Here, price is less than marginal cost, and marginal revenue is lesser than price. This means marginal revenue is less than marginal cost.

If price is above marginal cost, but marginal revenue is less than price. This marginal revenue may be above below or equal to marginal cost. in that case firms may or may not be in equilibrium.

If price equals marginal cost, since the marginal revenue is less than price. It is also less than marginal cost. So profit is not maximized.

For long run equilibrium, price should be equal to average total cost.

If price is greater than ATC, firms will be having profits which will attract other potential firms to enter the market. This will increase the supply, consequently price will fall and so will profit. This process continues till P=ATC.

Similarly, if price is less than ATC, firms will be having losses in the long run. The firms having losses will exit reducing supply. The price level will rise and so will profits. This continues till P=ATC.