Determination of Equilibrium price and output under monopolistic competition

Determination of Equilibrium price and output under monopolistic competition

The monopolistic competitive firm will come to equilibrium on the principle of equalising MR with MC. Each firm will choose that price and output where it will be maximising its profit. Figure shows the equilibrium of the individual firm in the short period.

MC and AC are the short period marginal cost and average cost curves. The sloping down average revenue and marginal revenue curves are shown as AR and MR. The equilibrium point is E where MR = MC. The equilibrium output is OM and the price of the product is fixed at OP. The difference between average cost and average revenue is SQ. The output is OM. So, the supernormal profit for the firm is shown by the rectangle PQSR. The firm by producing OM units of its commodity and selling it at a price of OP per unit realizes the maximum profit in the short run.

The different firms in monopolistic competition may be making either abnormal profits or losses in the short period depending on their costs and revenue curves.

In the long run, if the existing firms earn super normal profit, the entry of new firms will reduce its share in the market. The average revenue of the product will come down. The demand for factors of production will increase the cost of production. Hence, the size of the profit will be reduced. If the existing firms incur losses in the long-run, some of the firms will leave the industry increasing the share of the existing firms in the market. As the demand for factors becomes less, the price of factors will come down. This will reduce the cost of production, which will increase the profit earned by the existing firm. Thus under monopolistic competition, all the existing firms will earn normal profit in the long run.