Microeconomics Topic 10: Monopolistic Competition by

Normal profit under monopolistic competition

ronaldoyee_161 — 2017-08-06 05:00:09 UTC

When P=ATC, the firm will make a normal profit
The firm should continue operations because the revenue earned can cover all the cost incurred

Economic profit under monopolistic competition

ronaldoyee_161 — 2017-08-06 05:00:09 UTC

When P>ATC, the firm will make an economic profit.
The firm should continue operations because the revenue earned can cover all the cost incurred

Short run equilibrium under monopolistic competition

ronaldoyee_161 — 2017-08-06 05:00:09 UTC

A monopolistically competitive firm faces identical demand and cost curve be it in the short run or the long run.
AR>MR
Profit maximisation output level is when MR=MC
In the short run, the monopolistically competitive firm can earn either an economic profit, a normal profit or an economic loss.

Absence of barriers to entry and exit and its implications

ronaldoyee_161 — 2017-08-06 05:00:09 UTC

It is easy for any firms to enter and exit the monopolistically competitive market. As a result, the monopolistically competitive firm can only earn normal profit in the long run

Selling a differentiated product and its implications

ronaldoyee_161 — 2017-08-06 05:00:09 UTC

A monopolistically competitive firm has some market power because it sells differentiated products.
This means the product I sell is a close but not a perfect substitute for the product you sell.
The product differentiation can be real or perceived.
The monopolistically competitive firm's demand curve is downward sloping and is elastic because there are many substitutes available.
When the firms increase their price, they will lose some of their customers due to the downward sloping demand curve. On the other hand, when the firms decrease their price, they will gain some extra customers from their competitors.
Hence, monopolistically competitive firms will engage in non-price competition where they try improving other aspects of the product apart from the price. Non-price competition will help increase demand and make the demand less price elastic by developing customer loyalty.

A large number of firms and its implications

ronaldoyee_161 — 2017-08-06 05:00:09 UTC

Each firm has a small market share

Monopolistic Competition

ronaldoyee_161 — 2017-08-06 05:00:09 UTC

Monopolistic Competition, together with oligopoly, is in the middle of the extremes of perfect competition and monopoly.
A monopolistic competition market has many sellers selling a differentiated product. In a monopolistically competitive firm, no barriers exist to restrict entry and exit.

Economic loss under monopolistic competition

ronaldoyee_161 — 2017-08-06 06:39:17 UTC

When PThe firm should calculate its AVC to decide if it should continue operation or cease operation. The AFC must be incurred regardless of operation
If P>AVC, the firm should continue operation because the revenue can cover up all the TVC plus a portion of the TFC. If the firm cease operation, it will incur the full TFC which is higher
If PIf P=AVC, the firm can decide to continue or cease operation. This is because the revenue will cover up just nice all the TVC. If the firm cease operation, it incurs the TFC as well

Long run equilibrium under monopolistic competition

ronaldoyee_161 — 2017-08-06 06:43:21 UTC

In the long run, a monopolistically competitive firm can only earn normal profit because of the absence of barriers to entry and exit.
When the monopolistically competitive market is earning economic profit, it attracts other sellers to enter the market. The new firms will steal the existing firm's customer, causing their demand curve to shift leftwards until they earn a normal profit.
On the other hand, if the monopolistically competitive market is incurring economic loss, existing firms will leave the market, resulting in an increase in customers for existing firms, shifting their demand curve rightwards until they earn normal profit.
For perfectly competitive market,a normal profit is attained through the shifting of the supply curve; for the monopolistically competitive market, normal profit is attained through the shifting of the demand curve

Excess capacity

ronaldoyee_161 — 2017-08-06 06:57:44 UTC

A monopolistically competitive firm cannot produce at the minimum point of the LRAC because the demand curve is downward sloping. The demand curve will be tangent to the LRAC at a point leftwards of the minimum point.
Excess capacity is the difference between the ideal output (output level at the minimum LRAC) and the monopolistically competitive firm's output in the long run.
In short, the monopolistically competitive firm will sell lesser output at a higher price than a perfectly competitive firm.