The paper "Effect of a Fall in Demand on a Firm’ s Price and Profit - Air New Zealand" is an outstanding example of a micro and macroeconomic assignment. Price discrimination occurs when a firm successfully sells similar products at varied prices in diverse markets where such a difference in price is not because of differences in marginal cost. An example to demonstrate price discrimination in the airline industry is the case of Air New Zealand and Qantas where Qantas prices airfares at 25% lower in markets monopolized by Air New Zealand. The assumptions of monopolistic competition are as follows: Many producers and consumers hence concentration is low There is product differentiation hence consumers are aware of non-price differences among different competitor products. Products have some level of price control thus are classified as price makers. Low barriers to entry and exit Monopolistic competition is not efficient in the allocation of resources mainly because of the negatively sloping demand curve as well as its ability to determine the price in the market.
The negative slope of the demand curve means that monopolistically competitive firm is able to charge a price that is greater than marginal revenue.
The price is also greater than the marginal cost at the profit-maximizing level. This inequality between price and marginal cost contributes to inefficiency in the allocation of resources. The adjustment process of a firm in a monopolistically competitive industry is illustrated in figure 1. Figure 1: Effect of a fall in demand on a firm’ s price and profit If a firm is currently in the long-run, it means that the Average Total Cost Curve is tangent to the demand curve. At the same time, price is equal to the Average Total Cost hence; the firm is making zero profits.
Given this long-run position, a fall in demand has the effect of shifting the demand curve to the left in the short-run. The result is that the Average Total cost exceeds the price consequently giving rise to losses indicated by the shaded region. In the long-run, firms that are making losses will exit the industry. Demand in the remaining firms will increase to shift the demand curve rightwards. This returns the firm to a profit situation where the price is higher than the average total cost.
Cohn, SM 2007, Reintroducing Macroeconomics: A Critical Approach, London, M.E, Sharpe.