Assume that the plastics business is monopolistically...

Assume that the plastics business is monopolistically competitive. a. Draw a graph showing the long-run equilibrium situation for a typical firm in the industry. Clearly label the demand, $M R, M C,$ and $A T C$ curves. b. One of the major inputs into plastics is oil. Draw a new graph illustrating the short-run position of a plastics company after an increase in oil prices. Again, show all relevant curves. c. If oil prices remain at the new, higher level, what will happen to get firms in the plastics industry back to a long-run equilibrium? (Assume the firm's $A T C$ and $M C$ curves don't change in the long run.

Assume that the plastics business is monopolistically competitive.
a. Draw a graph showing the long-run equilibrium situation for a typical firm in the industry. Clearly label the demand, $M R, M C,$ and $A T C$ curves.
b. One of the major inputs into plastics is oil. Draw a new graph illustrating the short-run position of a plastics company after an increase in oil prices. Again, show all relevant curves.
c. If oil prices remain at the new, higher level, what will happen to get firms in the plastics industry back to a long-run equilibrium? (Assume the firm's $A T C$ and $M C$ curves don't change in the long run.

Key Concepts

Monopolistic Competition

Monopolistic competition is a market structure characterized by many firms selling differentiated products, which gives each firm some degree of market power. Firms in this market face downward-sloping demand curves and compete on aspects other than price, such as product features and branding. The competition is not as fierce as in perfect competition, yet there is free entry and exit, ensuring that firms earn zero economic profits in the long run.

Long?Run Equilibrium

In the long?run equilibrium for a monopolistically competitive firm, entry and exit force the firm's demand curve to become tangent to its average total cost (ATC) curve, implying zero economic profit. At this point, the marginal revenue (MR) equals marginal cost (MC), determining the profit-maximizing output, while the demand curve just touches the ATC curve, indicating that price equals ATC. This equilibrium condition ensures that no firm has an incentive to enter or exit the market.

Cost and Revenue Curves

Key graphical tools for analysis include the demand curve, which reflects the firm's perceived downward-sloping market demand; the marginal revenue (MR) curve, which lies beneath the demand curve due to the price reduction necessary to sell an additional unit; the marginal cost (MC) curve, which rises with additional production; and the average total cost (ATC) curve, which is used to determine the profitability of the firm. The intersections and relative positions of these curves determine both the short-run and long-run operation of the firm.

Short?Run Impact of Input Price Increases

A rise in the price of a major input, such as oil, affects the firm’s cost structure in the short run by effectively increasing production costs. This can result in a shift of the demand curve or a change in the firm's operating profits if the firm cannot immediately adjust its cost curves. The short-run graph will generally reflect a scenario where the firm may temporarily experience economic losses or reduced profits due to the higher input costs, even though fixed cost commitments might delay an immediate adjustment in the cost curves.

Adjustment Process in Response to an Input Price Shock

If higher input prices persist in the long run, the initial short-run losses force market adjustments. Existing firms may exit the market, thereby reducing the overall market demand for each firm’s product and moving the firm’s demand curve back towards tangency with its ATC curve. Despite the individual cost curves (MC and ATC) remaining unchanged, the exit of firms intensifies the market price for the remaining firms’ products, restoring the long-run equilibrium where each firm earns zero economic profit.

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