Short-run equilibrium
Producers in monopolistically
competitive markets, as well as all market types, are profit maximizes. This
means they will produce at the quantity for which their Marginal Benefit is
maximized; a.k.a. where Marginal Cost equals their Marginal Revenue (MC=MR).
If you draw a vertical line from the intersection point down to the x-axis,
that is the market quantity. To find the price, you must extend the vertical line
up to the Demand curve because Demand relates market
price to quantity, not the
Marginal Cost curve. Then draw a horizontal line to the y-axis and that is the
market price. These two values represent the short-run equilibrium for a
monopolistically competitive market.
Long Run Equilibrium:
Since producers are profit
maximizes, they will produce the quantity where MC=MR (same procedure as for
the short-run equilibrium). In a monopolistically competitive market there are low barriers to entry so it is easy for other firms to come in and steal
economic profit from the firms currently in the market. To counteract this,
producers in the market will produce at a quantity that yields zero economic
profit, because why would you join this market if there's no supernormal
profit? This means the quantity the firm produces will be both where MC=MR and
Price (the Demand curve) intersects the Average Total Cost curve. If you draw a
vertical line up from the market quantity, it will go through both of these points.
The price is again found by drawing a horizontal line to the y-axis.
PRICE AND OUTPUT DETERMINATION UNDER MONOPOLY
The object of the monopolist is to earn maximum profit. The monopolist will
charge such a price which will give him the maximum profit. He always compares
marginal revenue with cost at its output rate. The profit of firm is maximum
when its MR = MC and Marginal cost curve cuts the marginal revenue curve from
below. The MR curve in negatively sloped and it also lies below the AR curve at
all levels of output, except the first unit. The monopolist controls the whole
market and no new firm can enter into the market so the distinction between a
long run and short run is not necessary. The price and output determination can
be explained by the following diagram. :
EXPLANATION: - In this diagram AR curve is higher than
the MR curve. The MC curve cuts the MR curve at a point E. Equilibrium occurs
at a point E, where MR = MC. So the best level of output for the monopolist
firm is OF.
As regards the determination of price monopolist
fixes the price OP because the total revenue of the firm will be maximum at the
equilibrium output OF.
The cost of the firm will be = OSEF
the revenue of the firm will be = OPKF