MONOPOLISTIC COMPETITION

BASICS OF MONOPOLISTIC COMPETITION

EXAMPLES OF MONOPOLISTIC COMPETITION
IMPORTANT FEATURES OF MONOPOLISTIC COMPETITION

 A large number of firms

 Product differentiation
 Some influence over the price
 Non Price competition: Expenditure on advertisement and other
selling costs.
 Product variation
 Freedom of entry and exit
NATURE OF DEMAND AND MARGINAL REVENUE CURVES
UNDER MONOPOLISTIC COMPETITION

 Demand curve facing an individual firm under monopolistic competition slopes

downward – As monopolistic firms enjoys some control over the price of its product
since its product is different from other firms. So, when it raises the price of its product,
customers will go away to buy other products as a result quantity demanded will fall
and vice versa. Therefore, the demand curve facing an individual firm under
monopolistic competition slopes downwards.
 Demand curve facing a firm will be his average revenue curve. Thus the average
revenue curve of the monopolistically competitive firm slopes downward throughout its
length. Since average revenue curve slopes downward, marginal revenue curve lies
below it.
WHY IN MONOPOLISTIC COMPETITION AR CURVE IS SAME AS
DEMAND CURVE?

 The AR curve of a monopoly firm is the same as the market

demand curve because AR is always equal to the price.
 Under monopolistic competition, average revenue always
exceeds marginal revenue, while under
perfect competition they are the same. ... Average revenue
equals total revenue . The average revenue curve and the
demand curve are thus the same thing.
 NATURE OF DEMAND AND MARGINAL
REVENUE CURVES UNDER
MONOPOLISTIC COMPETITION

Demand curve facing a firm will

be its average curve. Thus the
average revenue curve of the non
monopolistically competitive
firm slopes downward
throughout its length. Sine AR
curve slopes downward, marginal
revenue curve lies below it.
WHY MR CURVE ALWAYS LIES BELOW AR CURVE?

 When a firm working under monopolistic competition sells more,

the price of its product falls, Marginal revenue therefore must be
less than price.

 Hence, marginal revenue is less than price, the marginal

revenue curve will lie below the demand curve.
 PRICE OUTPUT EQUILIBRIUM OF A FIRM
UNDER MONOPOLISTIC COMPETITION IN
SHORT RUN (PROFITS)
Demand curve for a firm is quite elastic as lots of
substitutes are available in the market. A firm in
order to maximise profits will equate MC with MR,
The firm will produces till the point Q where MC is
equal to MR. The demand curve DD indicates the
output OQ sold at price OP. In this equilibrium
position by fixing it s price at OP- Price and OQ-
output the firm is making economic profits equal to
the PACB area which is maximum.
(It must be understood that the PACB area profits
are in excess to the normal profits because the
normal profits which represent the minimum profits
necessary to secure the entrepreneurs services are
included in AC curve. Thus the PACB indicates
supernormal profits by the firm.)
 PRICE OUTPUT EQUILIBRIUM OF A FIRM UNDER
MONOPOLISTIC COMPETITION IN SHORT RUN
(LOSSES)
In this case a firm shows the case when demand or
AR curve for the product lies below the AC curve,
indicating that no output of the firm can be produced
at positive profits, Reason being the cost of
producing is higher than the Revenue earned from it.
However, the firm is in equilibrium at output OQ, by
fixing price at OC and output at OP, it is having
losses to the minimum. CBPA, coloured area is
shown as loss.
Thus we see that profits or losses depend upon the
position of the demand curve relative to the position
of the AC curve. Further a firm ay be making only
normal profits even in the short run if the demand
curve happens to be tangent to the average cost
curve.
 LONG RUN FIRMS EQUILIBRIUM UNDER
MONOPOLISTIC COMPETITION
In long run each firm will set price OP where MC is equal to
MR and hence profits are maximum. All firms are making
economic profits so there is no point cutting price below OP
It should be noted that in monopolistic competition firms
producing close substitutes will be only allowed to enter.
‘These economic profits will attract new firms into the field in
the long run.
Attracted by the comic profits more firms will enter the
market as a result…demand/AR curve to the left until it
becomes tangent to AC curve and the economic profits are
completely wiped out. This is shown in the diagram at a point
where AC iis tangent to AR/ Demand and by setting price OP
at OQ output. Because AR is equal to AC at this point firm
in long run will be making only normal profits,
Because there will be only normal profits therefore no more
tendency for the new competitors to enter he field and the
group as a whole will therefore be in equilibrium.