Canadian Microeconomics:Problems and Policies
At prices above $1.20, not even his mother will eat at Harry’s. Thus, under monopolistic competition, the fact that each firm’s product is somewhat different from its competitors’ can give it an opportunity to raise its price a little.
A similar effect occurs with price reductions: while large price reductions will attract many sales, for small price reductions demand will not be so elastic. A small price cut by Harry will not likely attract many more customers from his competitors…these customers are patronizing Harry’s competitors because they prefer their products, location or other features, and will not likely be lured away by the prospect of saving five or ten cents per burger at Harry’s. A large price cut is out of the question – while it would increase Harry’s sales greatly, he would lose money on every sale and go bankrupt.
In summary, then, the demand curve for the differentiated product of a firm in monopolistic competition is basically very elastic, but for small changes around the market price, it it less elastic, and possibly even inelastic. As a result, the firm has the opportunity to increase its price, within quite narrow limits, although it may or may not decide to actually do so.
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