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Monopolistic competition

Monopolistic competition
Monopolistic competition

What is Monopolistic? How does He Choose his output and Price?

Meaning of Monopolistic:- It is that market in which there are many sellers of a commodity, but the product of each seller differs from other sellers in the market. And There are also many buyers.

According to the:- “Monopolistic competition is a market situation where there are many producers but each offers a slightly different product”.

In other words:- Monopolistic refers to that market in which there are many sellers and buyers. But sellers sell slightly different products in the market. It means products are a close substitute. For Example– Toothpastes, Such as Pepsodant, Colgate, Close-up, Cibaka, patanjali, forever, Himalayan and so on.

Determination of Price and Output Under Monopolistic Competition

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Profit Maximization and Equilibrium under Monopolistic Competition

In the monopolistic competition, the main aim of each firm is to get maximum profit. We know that profit is maximum when MR is equal to MC. A firm under monopolistic competition produces up to that limit where its marginal Cost is equal to marginal revenue ( MC = MR ), and MC curve cuts MR Curve from below. When firms produce under these conditions, it will be in equilibrium Position.

Study of firm’s price and Output under monopolistic competition is made under two different time period

( 1 ) Short Run

( 2 ) Long Run

( 1 ) Short Run firm’s price and output in Monopolistic:-

Short run refers to that time period in which production can be increased but upto some extent as per the available production capacity. But there is no time available either to increase or decrease the fixed factors of production like machines, plants, factory building, etc.

In the short run, a firm will be in equilibrium when

  • Its MC = MR
  • MC curve cuts MR Curve from below.

However firms can face three situations

  1. Super Normal Profit
  2. Normal Profit
  3. Losses

(A) Super Normal Profit:- From the following figure we can understand it properly.

Monopolistic competition
  • It shows that the firm is in equilibrium at point E. Because at this point MC = MR.
  • At this point output is OM.
  • Price of equilibrium output is here as OP = AM.
  • This equilibrium price AM is greater than average cost as in BM ( AM > BM ).
  • Thus, here the firm earns Super Normal Profit equal to the difference between AB= AM-BM per unit.
  • Total super Normal profit of the firm in equilibrium is ABCP, the Shaded area.
  • Super Normal Profit = AR > AC

(B) Normal Profit:- In the short run, a firm under monopolistic competition will earn normal profit.

Monopolistic competition

However, from the following figure we can understand it properly.

  • At point E firm is in equilibrium where MR = MC at the output OM.
  • Price of equilibrium output is OP ( = AM) and average cost is OP ( = AM).
  • It is so because, AR curve is touching the AC curve at point A.
  • Hence, in the position of equilibrium AR is equal to AC
  • And the firm earns normal profit.

Normal Profit = AR = AC

(C) Minimum Loss:- Even in the short period a firm can incur loss of fixed cost. It is the minimum loss of firm.

Monopolistic competition
Monopolistic competition

However, It can be understood with the following figure.

  • It is evident that the firm will be in equilibrium at point E.
  • At this point MC = MR.
  • In the equilibrium the firm will produce OM output.
  • Price of the equilibrium Output OM is OP1 ( = AM ) and Average cost OP ( = BM ).
  • So Average cost is more than the price as ( AC > AR ).
  • Hence the firm suffers a loss equivalent to AB = BM – AM per unit.
  • Thus, in case of equilibrium the firm will get its AVC from the prevailing price AM.
  • But here it will have to incur loss of fixed cost equivalent to AB per unit.
  • Total loss of the firm will be BAP1P, the shaded area

  MINIMUM LOSS= AC – AVC

( 2 ) Long Run Firm’s Price and Output In Monopolistic:- Long run is that period in which a firm can change its production capacity in response to change in demand. Firm can change the size of its plant and machinery. Each firm will produce up to that limit where marginal revenue is equal to long run marginal cost.

Note:- In the long run, firms earn normal profit only. No one firm can get super normal profit in the long run. There are some reasons which are following.

  • If existing firms will earn supernormal profit, Then new firms will enter as entry is free. As a result , supply will increase. Again the price of supply products will decrease. Then, firms will be deprived of super normal profits.
  • If demands of products will increase. Then new firms will enter and they will sell their products at lower cost. And old firms will also decrease their price. Then, both old firms and new firms will earn normal profits instead of Super normal profit.
  • Due to free entry, when new firms join the industry, demand for factors of production increases leading to increased factor costs. Consequently average cost will increase. Other hand, low prices of products will cause supernormal profits to disappear.

Now we can understand with the help of the following figure.

Monopolistic competition
  1. LAC is a long run average cost and LMC Is long run marginal cost.
  2. AR is the average revenue and MR is the marginal revenue Curve.
  3. MC = MR at point E which is equilibrium point.
  4. OM is the equilibrium output and OP = AMP is the price of equilibrium output.
  5. At equilibrium output OM, average revenue curve is tangent to long run average cost curve at point A which means that in equilibrium situations price and long run average cost are equal.
  6. Hence, the firms will earn only normal profit.

Competition:- Thus, Monopolistic market earns SuperNormal Profit, Normal Profit and Minimum Loss in Short run. But in the Long Run it earns Normal Profit. Which we can consider in the above description analysis of monopolistic competition.

Important Other question of Economics

Equilibrium Under Perfect Competition

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Monopolistic competition
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