Monopolistic Competition Short Run Equilibrium (Profit Maximisation)

Due to product differentiation and the availability of several near substitutes, a monopolistically
competitive firm's demand curve slope downward. Profit maximisation and loss minimization are the
goals of the company. Where marginal revenue equals marginal cost (MR = MC), a short-run equilibrium
or the rule of profit maximisation is reached. The company is in equilibrium at point E*, whereas the
equilibrium price and quantity are located at points P* and Q*, respectively.

P(RM)

MC

P*

E* AR = D

MR
Q(unit)
Q*

Monopolistically competitive firms have three types of profit which are the supernormal profit,
subnormal profit and normal profit.

When AR surpasses AC at the equilibrium point MR = MC, the company is operating at a supernormal
profit. The price that maximises profit is established at A, while the production that maximises profit is
produced at Q. The supernormal profit made by monopolistic competition is shown by the darkened
region.

P(RM) MC

C AC
A (10)
PROFIT
B (5) D
E AR = D

MR
Q(unit)
Q (15)
Monopolistic competition earns supernormal profit when AR > AC and TR > TC at MR =MC.

TR =RM10 x 15 = RM150 TC = RM5 x 15 = RM75 Tπ = TR – TC

= RM150 – RM75

= RM75 (supernormal profit)

When AR is lower than AC at the equilibrium point of MR = MC, a company may have subnormal profit.
At points A and Q, respectively, the equilibrium output and price are found. The darkened region BDCA
depicts the losses the company experiences.

P(RM) AC
MC

B (15) D

LOSS
A (10) C

E AR = D

MR
Q (unit)
Q (15)

Monopolistic competition faces subnornmal profit when AR < AC and TR < TC at MR = MC.

TR =RM10 x 15 = RM150 TC = RM15 x 15 = RM225 Tπ = TR – TC

= RM150 – RM225

= - RM75 (subnormal profit)

The firm is facing normal profit when AR and AC are equal at the equilibrium point MR = MC. The
equilibrium price determined at point A and the equilibrium quantity at Q. The revenue obtained by the
firm is just enough to cover its cost.

P(RM)

AC

MC
C
A (10)
AR = D

MR
Q (unit)
Q (15)

Monopolistic competition obtains normal profit when AR = AC and TR = TC at MR = MC.

TR =RM10 x 15 = RM150 TC = RM10 x 15 = RM150 Tπ = TR – TC

= RM150 – RM150

= - RM0 (normal profit)

Monopolistic Competition Long Run Equilibrium

In the long run, monopolistically competitive firms will only earn normal profit due to the
freedom of entry and exit. The long run equilibrium of the firm depends on the short run
equilibrium. The two effects of entry and exit are described below.

Effect of Entry

When monopolistically competitive businesses in an industry make supernormal profits in the

near run, it will entice numerous new firms to enter the market with the goal of maximising
profit. As a result, the demand curve of monopolistic competition will collapse and shift to the
left. This is because the enterprises have a lower fraction of overall demand and have many
substitutes in the market. Reduced demand affects business profit. The procedure will continue
until the firm's demand curve is tangent to its average cost curve. As a result of the introduction
of new businesses into the sector, monopolistically competitive enterprises will only make
normal profit in the long run.

Effect of Exit

Some of the current businesses will leave the industry out of fear of experiencing the same
losses as the monopolistically competitive enterprises whenever they experience losses or
negative profits. Therefore, when fewer substitutes are available and the percentage of total
demand increases, the demand curve of the monopolistically competitive companies will also
climb. Till the losses vanish and the demand curve is tangent to the average cost curve, the
process will go on. This shows that because of the impact of a few businesses leaving the sector,
firms under monopolistic competition ultimately make typical profits.

P(RM)
LRMC

LRAC

P = LRAC

LRAR = D
E*

LRMR

Q (unit)
Q
At point E*, where MR and MC cross, the long-term equilibrium is attained. The equilibrium
quantity is achieved at Q and the price is constant at P. The monopolistically competitive firms
earn normal profit in the long run when AR equals LRAC due to freedom of entry and exit.