Suppose the accompanying graph depicts a monopolistically competitive firm. Which of the following is a key characteristic of monopolistic competition illustrated by the graph?

• A. There are significant barriers to entry preventing new firms from entering the market.
• B. The firm is a price taker and faces a perfectly elastic demand curve.
• C. The firm faces a downward-sloping demand curve due to product differentiation.
• D. The firm produces at the minimum point of its average total cost curve in the long run.

Answer: (C)

Verified step by step guidance

1. Understand the market structure: Monopolistic competition is characterized by many firms selling differentiated products, which means each firm has some control over its price.
2. Identify the shape of the demand curve faced by the firm: In monopolistic competition, the demand curve is downward sloping because the firm's product is differentiated, so it can raise price without losing all customers.
3. Contrast with perfect competition: In perfect competition, firms are price takers and face a perfectly elastic (horizontal) demand curve, which is not the case here.
4. Consider barriers to entry: Monopolistic competition typically has low or no significant barriers to entry, allowing new firms to enter the market freely, unlike monopoly.
5. Examine production efficiency: Firms in monopolistic competition do not produce at the minimum point of their average total cost curve in the long run, which differs from perfect competition where firms produce at minimum ATC.