Introduction:

Monopolistic competition is a market structure characterized by a large number of firms selling similar but not identical products. Firms in this structure have some degree of market power due to product differentiation but also face competition from other firms offering close substitutes. Here’s how price and output are determined in monopolistic competition:

Price and output determination under monopolistic competition:

Price and output determination under short-run period:

Short run or period is a period of time where in time is inadequate to make all sorts of changes and adjustment in the productive process. the demand and cost condition may vary substantially forcing the firm either to charge higher or lower price leading to super normal profit or losses. However each firm fixes such prices and produce output which maximize its profit. the equilibrium price and output is determined  at a point where short run marginal cost equal marginal revenue thus one condition is required for short run equilibrium MC=MR

The first diagram show super normal profit, in this case price AR is greater than AC (cost per unit) MQ is a cost per unit and total cost for OQ output is MQ* OQ = ONMQ. PQ is the price or revenue per unit and the total revenue for OQ output is PQ*OQ =ORPQ.

Supernormal profit=TR (ORPQ)-TC (ONMQ)

Hence, NRPM is the profit

The second diagram shows losses, in this case AC is greater than AR. PQ is a cost per unit and the total cost is PQ *OQ=OR PQ. MQ is a revenue per unit and the total revenue for OQ output is MQ*OQ=ONMQ.

Total losses=TC (ORPQ)-TR (ONMQ) =NRPM. Thus in the short run there will be place for supernormal profit or losses.

Price and output determination under long run period:

Long run is a period of time where in a firm will get a adequate time to make all kinds of changes in the production process or business. A firm can initiate several measure to reduce its production cost and enjoy all the benefits of large scale production. Plant capacity can be either expandable or contracted dependent on the demand for products. Total number of firms in the industry change as there is free entry and exit of firm ,total volume of output is produced substantially changes consequently, cost condition changes in the long run. While fixing the price, a firm in the long run should consider it’s AC and AR. generally speaking in the long run the firm earns only normal profit. If AR is greater than AC there will be super normal profit this leads to entry of new firms. Increase in the total number of firms, total production, fall in price and decline in profit ratio elimination of excess profits.

 On the other hand if AC is greater than AR there will be losses, this leads to exit of old firm. Decrease in the number of firms, total production price and prices increase in profit ratio, avoiding of losses. Thus the entry and exit of firm continuous till AR becomes equal to AC consequently in the long run two conditions are required for equilibrium of the firm.

• MR=MC
• AR=AC

 However it should be noted that price is greater than MR and MC in the long run.

In the diagram E is the equilibrium position where MR=MC and MC curve cuts MR curve from below at p. AR= AC= price.

It is necessary to understand that a firm lender monopolistic competition in the long run also can earn super normal profit. Professor Hague suggests that a firm can go for innovation to introduce new change in the context of a modern competitive business. This appears to be more realistic because today almost all firms make heavy profits and it is regarded as one of the most practical form of market situation in the present day world.

also read: what is price discrimination/ explain its types.