Question

Explain price and output determined under monopolistic competition with help of the diagram.

Answer 1

Monopolistic competition refers to a market situation where there are many firms selling differentiated products.

Price and output determination:
Nature of cost and revenue curves:
The monopolistic firm sells large quantities at less price. So, it faces a downward-sloping demand curve. AR curve is fairly elastic. MR curve falls below AR. AC curve will be ‘U’ shaped.

Condition for equilibrium:
MC = MR, MC curve should cut MR from below. If MC is less than MR, the sellers will find it profitable to expand their output.

• Short-run equilibrium:

Profit is maximised when MC = MR. From the diagram.
OM – Equilibrium output OP – Equilibrium price
TR – OMQP TC – OMRS
Profit = OMQP-OMRS
= PQRS
This is super normal profit in the short run.
A monopolistic competitive firm may also incur a loss in the short run.

As shown in the diagram, the AR and MR curves are fairly elastic.
At equilibrium output is OM, price is OP
TR – OMQP
TC-OMLK
Total loss = TR-TC
= OMQP – OMLK
= PQLK

• Long-run equilibrium:
  In the long run, the AR curve is more elastic or flatter. Hence, the firms will only earn a normal profit.