PRICE AND OUTPUT DETERMINATION UNDER MONOPOLISTIC COMPETITON

MONOPOLISTIC COMPETITION
Monopolistic competition is a market structure in which there are many sellers of a commodity, but the product of each seller differs from that of the other sellers in one respect or the other. According to J.S. Basins, monopolistic competition is market structure where there is a large number of small sellers, selling differentiated but close substitute products.

CHARACTERISTICS OF MONOPOLISTIC COMPETITION

Large number of firms and buyers Product differentiation Freedom of entry and exit of firms Selling costs Price control Limited mobility Imperfect knowledge Non-price competition

DETERMINATION OF PRICE AND OUTPUT UNDER MONOPOLISTIC COMPETITION

Firm under monopolistic competition produces up to that limit where its marginal cost is equal to marginal revenue, (MC=MR) and MC curve cuts MR curve from below. In case of monopolistic competition, price and equilibrium position of firm and group will be studied in two parts: (1)Firms equilibrium and (2) Groups equilibrium.

EQUILIBRIUM OF THE FIRM

LONG RUN

SHORT RUN

SUPER NORMAL MINIMUM NORMAL PROFIT LOSS PROFIT

NORMAL PROFIT

SHORT PERIOD EQUILIBRIUM

Short-run refers to that time period in which output can only be increased by changing the quantity of variable factors. there is no time to change in fixed factors of production like machines, plants, factory, building etc.

SUPER NORMAL PROFIT Y

M C A P REVEN UE C B E M R A R A C

OUTPUT

Firm is in equilibrium at point E, because at this point MC=MR. Point E indicates that the firms equilibrium output is OM. Price of equilibrium output is OP(=AM). AM is greater than the BM. Hence the firm earns super normal profit equivalent to difference between AM and BM. Total super normal profit is ABCP.

NORMAL PROFIT
Y MC AC P REVEN UE E A R O M OUTPUT M R X A

Firm is in equilibrium at point E where MC=MR and OM will be equilibrium output. Price of the equilibrium output is OP(=AM) and average cost is also OP(=AM). It is so because, AR curve is touching AC curve at point A. Hence AR=AC and firm earns normal profit.

MINIMUM LOSS
LOSS B A M C SAC AVC

REVENU E

P P
1

E MR=MC AR O M OUTPUT M R X

In this firm will be in equilibrium at point E and MC=MR. Price of equilibrium output OM is OP1(=AM) and average cost OP(=BM) and AC>AR. Hence a firm suffer a loss equivalent to BM-AM=AB per unit. But price of equilibrium output OM=AVC as AVC touches curve AR at point A and at point A firm will have to incur loss of fixed cost equivalent to AB per unit then the total loss of firm will be BAP1P.

LONG PERIOD EQUILIBRIUM

Long period refers to that time period in which output can be increased by making changes in the quantity of both fixed as well as variable factors inputs. In long run each firm will produce up to that limit where MR=long run MC. In long run firm earn only normal profit.

NORMAL PROFIT
Y LM C LAC REVENU P E A

E MR=M C MR O M

AR

OUTPUT

In this MC=MR at point E which is equilibrium point. OM is equilibrium output and OP(=AM) is the price equilibrium output. At equilibrium output OM, average revenue curve is tangent to LAC curve at point A which means AR=LAC. Hence firms earns only normal profit.

CONCLUSION
In monopolistic competition every firms enjoys super normal profit, normal profit, minimum loss in short run but in long run a firm enjoys only normal profit.