Monopolistic and Perfect Competition

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# Monopolistic and Perfect Competition

The long-run equilibrium of a firm under perfect competition and monopolistic competition is similar in some respects. In both the cases due to the condition of free entry, there are no supernormal profits. The short – run super normal profits, if any, are competed away in the long – run. Thus, in both cases, the long – run equilibrium is where MC = MR and AC = AR. But while under perfect competition, not only MC = MR, but AR is also equal to MR so that all the four are equal, MC = MR = AC = AR. However, under monopolistic competition while MC = AR, but since MR < AR therefore, in equilibrium MC < AC. The inequality MC < AC makes all the difference to price, output and economic efficiency under monopolistic competition. Under perfect competition MR = MC = AC = AR at the minimum point of the AC curve. But under monopolist competition MR = MC but MC being less than AC, the point of equilibrium corresponds to that part of the AC curve which is to the left of the minimum point. Hence, though there are no super normal profits in both perfect as well as monopolistic competition, the price is higher and output lower under monopolistic competition than under perfect competition.

Under perfect competition in the long – run, the firm’s marginal cost curve MC cuts the marginal revenue curve MR at its minimum point E. this gives the equilibrium level of output OM and the price PM. Since AR = MR, the firm does not make any super normal profits.

Under monopolistic competition, the firm’s MC curve cuts the marginal revenue curve MR1 at point E1. The equilibrium level of output is OM1 and the price P1M1. At this price, since the firms average cost is equal to average revenue because AR1 is tangent to AC, there are no super normal profits The tangency is towards the left of the lowest point on the AC curve (in the region of the increasing returns). In this way, there is an unutilized excess capacity with this firm and also with other firms in the industry. The price, P1 M1 which is shown by the height of the AR curve is, however, higher than PM that would have been under perfect competition. This higher price is not giving the producers extra profits. Their cost of production is higher and so their profits remain just the normal in spite higher price.

Thus, in both cases, there are no super normal profits, but the price competition is than the price under monopolistic competition. The output under perfect competition is OM which is higher than the output under monopolistic competition OM1. The segment of the curve P1P or unproduced output M1M represents the excess capacity under monopolistic competition.

Equilibrium of the Firm under perfect Competition and Monopolistic Competition: A Comparative Picture

 Perfect Competition Monopolistic Competition Each firm faces a horizontal demand(AR) curve because their products are homogenous. Every Firm is a price taker. Short-run equilibrium is at the output level where MR=MC but AR may be more than AC. In short-run, firms may be making super normal profits. In the long run, there are no super normal profits as MR = MC and AR = AC In long-run equilibrium P(AR) = MC. The long-run equilibrium is at the minimum point AC thus each firm produces capacity output. While output is large, price and AC under the long-run equilibrium are lowest as each firm produces optimum level of output. Long-run equilibrium denotes most efficient allocation of resources. Each Firm faces a downward sloping demand curve for their non-identical differentiated products. Every firm decides the price of its product. Short-run equilibrium is where MR = MC but AR may be more than AC. In short-run firms may be making super normal profits. In the long run, there are no super normal profits as MR = MC and AR = AC In long-run equilibrium P (AR) < MC. The long-run equilibrium is towards the left portion of the AC curve thus leaving every firm with excess capacity. Output and production level is lower but price and AC under the long-run equilibrium are not the lowest possible because each firm produces less than the optimum level of output. Long-run equilibrium, even with no super normal profit prevents the efficient allocation of resources.

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