A2 UNIT 3

Ch-4 – Monopolistic Competition

4.1 Features

• Many firms producing a slightly differentiated product

• Firms cannot influence the market price
• Normal profits in long run, as there are few or no barriers to entry
and exit
• Allocatively and productively inefficient in the long run

Examples include hairdressers, Chinese or Indian restaurants.

4.2 Short Run Supernormal Profit

The firm will produce output level Q1, where MC = MR (profit

maximising output level). The shaded area in the diagram is the
supernormal profit, as AR>AC.

In the long run, these profits will disappear as more firms will enter the
market (as there are no barriers to entry).
4.3 Short Run Loss

The firm will produce output level Q1, where MC = MR (profit

maximising output level). The shaded area in the diagram (P1,C1,A,B) is
the loss, as AR<AC.

In the long run, these losses will disappear as firms will exit the market
(as there are no barriers to exit).

4.4 Long Run Normal Profit

Firm produces at MC = MR, to maximise profits. As AR = AC, the

firms earns normal profits in the long run.

Productive efficiency does not exist, as the firm is not producing where
average costs are minimum.

Allocative efficiency does not exist, as the firm is not producing where
Price = Marginal Cost (P=MC)