Explain how price and output are determined under monopolistic competition in the short run and long run

Short run

Short-run refers to that period in which a monopolist cannot change the fixed factors. However, the monopolist is free in determining price due to lack of competition

In short run equilibrium whether the firm makes an abnormal profit, normal profit or loss, it depends on the level of AC and AR which can be shown as follows:-

• If AR=AC, the firm receives a normal profit.
• If AR> AC, the firm receives abnormal profit.
• If AR< AC, the firm bears the loss.

The following conditions must be fulfilled in order to attain equilibrium under monopoly:-

• MR must be equal to MC
• MC must intersect MR from below.

The equilibrium position of a monopoly firm can be graphically presented as follows:-

Abnormal profit

In the first fig. (a), the equilibrium point is ‘E’ when MC cuts MR from below. The equilibrium level of output is determined at OQ. The level of revenue earned is OP and the cost incurred is OC. Since Revenue is greater than cost, the firm earns abnormal profit equal to the shaded area (ABPC).

Loss

In the second figure, point E is the equilibrium point where MC intersects MR from below. The equilibrium level of output is OQ. The cost incurred is OC and the revenue earned is OP. Since cost is higher than revenue, the firm bears loss equal to the shaded area (ABCP).

Normal profit

In the third fig. (c), the equilibrium point is at ‘E’ where the conditions for equilibrium are fulfilled, i.e. MC = MR. The equilibrium level of output is OQ. The revenue and cost are at the same level (OP). The firm earns just a normal profit to sustain its business.

Long run

The firm earns normal profit because of the free entry of new firms; the supplier’s substitutes enter the market, so demand is shared among more brands. The firm earns just a normal profit to sustain its business.