Imagine that a local retail market is monopolistically competitive. Each firm (and potential entrant) is identical and faces a marginal cost that is independent of output and is equal to $100 per unit. Each firm has an annual fixed cost of $300 000 per month. Because each active firm perceives itself facing a price elasticity of demand equal to -2, the inverse price elasticity condition implies that the profit maximizing price for each firm is (P - 100) / P = ½ or P = 200. If each firm charges an equal price they will evenly split the overall market demand of 96 000 units per month.
a) How many firms will operate in this market at a long-run equilibrium?
b) How would your answer change if each firm faced a price elasticity of demand of -4/3 and charged a profit maximizing price of $400 per unit?