MANAGERIAL ECONOMICS

Monopolistic Competition in
the Short-run and Long-run
Biplab Sarkar
Department of Management Studies
MANAGERIAL ECONOMICS

Monopolistic Competition in the Short-run

and Long-run

Biplab Sarkar
Department of Management Studies
MANAGERIAL ECONOMICS
Monopolistic Competition

✓ Monopolistic competition is a market structure in which

firms are price setters but entry is easy.

✓ Example: Plumbers, electrician in a small town.

MANAGERIAL ECONOMICS
Characteristics of a Monopolistic Competitive Market

Large number of sellers

Monopolistic Competition

Product differentiation

Freedom of entry and exit of firms

Every firm has independent policy

Non-price competition
 MANAGERIAL ECONOMICS
Monopolistic Price Determination in Short-Run

PRICE AND OUTPUT DETERMINATION OF A FRIM UNDER MONOPOLISTICCOMPETITION : A CASE OF

SHORT PRIOD EQUILIBRIUM:
The analysis of short period equilibrium of a firm under monopolistic competition is basedon the following assumptions:
(1) Large number of sellers who behave independently.
(2) Product of each seller is different (i.e. product differentiation).
(3) The firm has determinate demand curve (AR) which is elastic.
(4) No new firms enter the industry in short period situation.
(5) Short run cost curves of each firms differ from the other.
(6) Factor services are in perfectly elastic supply.

Given these assumptions, each firm fixes such price and output as maximizes its profit. The equilibrium price and output is
determined at a point where the short period marginal cost equals marginal revenue. Since the cost differs in short period, a
firm can earn normal profits, super normal profit or incur losses. This analysis can be very well depicted in the following
diagram.
MANAGERIAL ECONOMICS
Monopolistic Price Determination in Short-Run

The diagram shows the super normal profit situation, normal profit situation and losses situation of a firm under
monopolistic competition in the short period. AR and MR are average revenue and marginal revenue of the firms
SMC and SAC are short period marginal cost curves and short period average cost curves and of the corresponding
firms operating under monopolistic com-petition in short period.
 MANAGERIAL ECONOMICS
Monopolistic Price Determination in Short-Run

1. In diagram (a) shows the short period marginal cost curves (SMC) intersects the marginal revenue curve (MR) at point E from below which
establishes equilibrium at E point. Here the total output is produce equal to OQ, and the price (per unit) OP is maintained and the cost per unit is OT
or RQ. Hence the difference between price and cost i.e. (OP-OT=PT) shows the profits of the firm, then the total profit at equilibrium position (E)
would be
PT × OQ (OQ = TR) = PTMR

Thus, the firm enjoys super normal profit equal to the area PTMR in short period under monopolistic competitive market structure.

2. Likewise, the diagram (b) shows the normal profit situation of a firm under short period in a monopolistic competitive market. The diagram depicts
the same equilibrium point E which is derived with intersection of SMC and MR and E point shows the same price and same cost for the product i.e.
OP is the per unit price of the product and MQ or OP (as MQ = OP) is the cost (per unit) of the product. Here both price and cost are equal and same
and the difference which determines the size of the profits is nil. Thus, here the firms enjoy normal profit. It just covers its short-run average unit
cost as represented by the tangency of demand curve (AR) and the short period average cost curve (SAC) at M earns normal profits.

3. The diagram (c) shows a situation where the firms is unable to cover its short period average cost (SAC) and tends to incur losses. The equilibrium
point E is established as SMC equals MR but the short period average cost is higher than its average revenue and the firm has to incur losses. In this
situation. MQ or OT is the cost per unit which is higher than the price (AR) where price per unit is equal to OP and their difference shows the losses
(i.e. OT - OP = PT loss per unit) and total output produced is equal to OQ then the total loss then firm would incur is equal to the area PTMR. This
area PTMR shows
MANAGERIAL ECONOMICS
Monopolistic Price Determination in Long-Run

PRICE AND OUTPUT DETERMINATION UNDER MONOPOLISTIC COMPETITION: A CASE

OF LONG PERIOD EQUILIBRIUM:
In the long period the price and output policy of an individual firm is determined by the one general
principle where Marginal revenue (MR) and Marginal cost (MC) are equal to each other as shown in the
short period. The firm can maximise its net profits by equating the long run marginal cost with its marginal
revenue. In long period the individual firm as well as the group as a whole remain in stable equilibrium
whereas in short period the individual firm is in equilibrium but the group is not in stable equilibrium. So, it
is possible to achieve the full equilibrium position in the long period under monopolistic competitive market
structure.
To achieve the position of full equilibrium in the long run two adjustments have to be made.
(1) All the quantity offered for sale must be equal to its demand in the market at a given price.
(2) Entry and exit of firms in response to the general position of the existing firm.
MANAGERIAL ECONOMICS
Monopolistic Price Determination in Long-Run
THANK YOU

Biplab Sarkar
Department of Management Studies
biplabsarkar@pes.edu
+91 80 6666 3333 Extn 337