Question 1 of 2

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The restaurant business in town is a monopolistically competitive industry in long-run equilibrium. One restaurant owner asks for your advice. She tells you that, each night, not all tables in her restaurant are full. She also tells you that she would attract more customers if she lowered the prices on her menu and that doing so would lower her average total cost. Should she lower her prices?

No, she should not lower her prices.

Yes, she should lower her prices.

She should not lower her prices. Since the industry is in long-run equilibrium, each restaurant makes zero profit. The restaurant owner is producing at the point where marginal revenue and marginal cost are equal. Further, the price is equal to average total cost, so she makes zero profit. If she were to lower the price, she would attract more customers but any increase in quantity beyond the point where marginal revenue and marginal cost are equal will result in greater losses. For further review see section, “Monopolistic Competition in the Long Run.”

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What would happen to the restaurant owner’s profit if she were to lower the price so that she sells the minimum-cost output?

The restaurant owner would experience a loss, setting a lower price will cause the marginal cost of providing additional meals would exceed the marginal revenue.

The restaurant owner would have the same profits as previously. Setting a lower price will attract a few more customers which will exactly offset the effects of lower prices.

The restaurant owner would experience a profit, setting a lower price will attract more customers. She will sell more meals to compensate for the lower prices.

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