CHAPTER 12 • Monopolistic Competition and Oligopoly 459 P1 F IGURE 12.3 D1(0) FIRM 1’S OUTPUT DECISION Firm 1’s profit-maximizing output depends on how much it thinks that Firm will produce If it thinks Firm will produce nothing, its demand curve, labeled D1(0), is the market demand curve The corresponding marginal revenue curve, labeled MR1(0), intersects Firm 1’s marginal cost curve MC1 at an output of 50 units If Firm thinks that Firm will produce 50 units, its demand curve, D1(50), is shifted to the left by this amount Profit maximization now implies an output of 25 units Finally, if Firm thinks that Firm will produce 75 units, Firm will produce only 12.5 units MR1(0) MC1 MR1(75) 12.5 MR1(50) 25 D1(50) D1(75) 50 75 Q1 cost MC1 is constant As shown in the figure, Firm 1’s profit-maximizing output is 50 units, the point where MR1(0) intersects MC1 So if Firm produces zero, Firm should produce 50 Suppose, instead, that Firm thinks Firm will produce 50 units Then Firm 1’s demand curve is the market demand curve shifted to the left by 50 In Figure 12.3, this curve is labeled D1(50), and the corresponding marginal revenue curve is labeled MR1(50) Firm 1’s profit-maximizing output is now 25 units, the point where MR1(50) = MC1 Now, suppose Firm thinks that Firm will produce 75 units Then Firm 1’s demand curve is the market demand curve shifted to the left by 75 It is labeled D1(75) in Figure 12.3, and the corresponding marginal revenue curve is labeled MR1(75) Firm 1’s profit-maximizing output is now 12.5 units, the point where MR1(75) = MC1 Finally, suppose Firm thinks that Firm will produce 100 units Then Firm 1’s demand and marginal revenue curves (which are not shown in the figure) would intersect its marginal cost curve on the vertical axis; if Firm thinks that Firm will produce 100 units or more, it should produce nothing REACTION CURVES To summarize: If Firm thinks that Firm will produce nothing, it will produce 50; if it thinks Firm will produce 50, it will produce 25; if it thinks Firm will produce 75, it will produce 12.5; and if it thinks Firm will produce 100, then it will produce nothing Firm 1’s profit-maximizing output is thus a decreasing schedule of how much it thinks Firm will produce We call this schedule Firm 1’s reaction curve and denote it by Q*1(Q2) This curve is plotted in Figure 12.4, where each of the four output combinations that we found above is shown as an x • reaction curve Relationship between a firm’s profitmaximizing output and the amount it thinks its competitor will produce