Demand for laundry soap is Qd = 100,000 10,000P.

Costs for producing this good are:

TCi = 400 + 2*qi + .01 qi 2
a.

First imagine the firm was in long-run equilibrium under perfect competition. What would be the
output per firm, market output, price and number of firms? What is consumer surplus?

Given how the short run and long run cost curves are related, in a long run equilibrium we have:
p = LAC= SAC= LMC = SMCY,
We have LAC(q) = 400/q +2 + .01q. This is minimized where the derivative is zero:

400/q2 + .01 = 0,

or q2 = 40000. Or, q= 200. Thus output per firm is 200.

The minimum of LAC is LAC(200) = 400/200 +2 +.01(200)= 6
Thus the long run equilibrium price is 6.
Aggregate demand at the price 6 is Qd = 100,000 10,000(6)= 40000 ,
So, the number of firms is Total demand/ output per firm= 40000/200= 200
Consumer surplus= (1/2)(Maximum willingness to pay price- Equilibrium price)(Equilibrium quantity)= (106)(40000)= 800,000

b.

Now, suppose that the same number of firms existed as in part a, but the market structure was
monopolistic competition. Find the output per firm, market output, price, and consumer surplus.
Is this market in LR equilibrium now? How can you tell?
In monopolistic competition, MR = MC
Qd = 100,000 10,000P,
Or, P= 10 1/10000(Q)
TR = 10Q 1/10000Q2
MR= 10 2/10000Q
TC= 400 + 2*qi + .01 qi 2
= 400 +2*Q/200 +.01(Q/200)2
MC= 1/100 + .01/20000(Q)
Equating MR=MC, we get,
1/100 + .01/20000(Q)= 10 2/10000Q
Or, (4.01/20000)(Q)= 999/100
Q= 49825.43=49825 (approx.)
q= Q/200= 49825/200= 249.125= 249 (approx.)
p= 10 1/10000(49825) = 5.0175= 5.02 (approximately)
Consumer surplus = (10 5.02)(49825) = 124064.25

In long run, P = ATC = LRAC which indicates that a firm is producing breakeven output, earning
exactly a normal profit.
Here, LAC(q) = 400/q +2 + .01q = 400/(249) +2 +.01(249) = 6.09
As P is not equal to the average cost, the market is not in long run equilibrium.

c. Based on your answers to a and b above, briefly explain these terms: "excess capacity"; "brand
proliferation", "price of variety".
Excess Capacity: In long run, equilibrium is at the minimum of the LRAC curve. However, when production
takes place at a point on the falling curve of LRAC as in the case above, production takes place at excess
capacity. Resources in a society are fully utilised when they are used to produce the level of output at
minimum long-run average cost. A monopolistically competitive firm produces less than the optimum, that
is, the output corresponding to the lowest point of long-run average cost curve. The amount by which the
actual long-run output of the firm under monopolistic competition falls short of the minimum LRAC output
is a measure of excess capacity, implying un-utilised capacity.
Brand Proliferation: Brand proliferation implies that the same products is sold in many brands with slight
variations in the products. However, excessive brand proliferation leads to deterring of new firms to enter
the market, thus, keeping the industry at excess capacity.
Price of variety: Because of product differentiation, firms can charge separate prices for their products. This
pricing power causes a dead weight loss which can be called the price of variety.