Equilibrium Price and Output Determination under Monopolistic Competition

Short-Run Equilibrium

In short-term equilibrium, the company creates a unique product and gains some monopoly power. The company won't have time to adjust the size of the plant (or capacity) in a short amount of time, and no new companies will enter the product group. The monopolistically competitive firm will now produce at the output level where marginal cost equals marginal revenue in order to maximize its profits.

The level of output is set by a monopolist when both of the requirements for profit maximization are met: a) MC = MR and b) the slope of MC > the slope of MR. Being the only vendor, the monopolist bases the cost of his good on the law of demand. As a result, a firm's demand curve (AR) falls downward. In a situation of perfect competition, the firm is a price-taker and its only option is to choose its production. Setting the price and determining his output are two considerations the monopolist must make. The two choices are interdependent, nevertheless, because of the demand curve's downward slope. The ability to alter a product's price is the essence of monopolistic power.

The short-term equilibrium does not imply that all businesses have the same pricing structure. Every company looks for the position that would maximize its profits. It is not a given that all businesses would see anomalous profits quickly in monopolistic competition. It's possible for some businesses to experience abnormal profit while others suffer losses or merely generate regular profit. Like in other market conditions, the firm facing monopolistic competition must immediately incur some fixed expenses that are unrelated to the output volume.

When a monopolist corporation creates any level of output at a point where two conditions are met, it must realize three options. As follows:

• The company makes an excess profit if AR > AC.
• Firm receives typical profit if AR = AC.
• Firm bears the loss if AR <  AC.

Long Run Equilibrium

Long-term, the monopolist will have enough time to increase the size of its plant or utilize it at any level to increase profit. In other words, because there is enough time, the market supply can be altered in response to changes in the market demand. Due to the difficulty of bringing in new businesses, there is a chance that the company will eventually make an excessive profit. However, the size of his plant and the extent to which any particular plant size is utilized entirely depend on the market's size, demand, and cost structure. The alternative plants, including various plant sizes, that the company is to choose for operation in the long run are presented by the long-run average cost curve and its associated long-run marginal cost curves. The monopolist will make a rational surplus profit if there is sufficient demand for the product on the market to support the output generated at maximum capacity.

However, he only runs his facility at a sub-optimal scale and makes less excess profit if the market size or demand is modest. Similar to the last example, he operates his factory at higher than ideal capacity and generates greater surplus profit if market demand is higher or the market is larger. Additionally, the company will operate at a location where the short-run average cost is perpendicular to the long-run average cost curve. However, because of flaws in the market, the monopolist runs its facility at a size that is less than ideal.

Reference

Koutosoyianis, A (1979), Modern Microeconomics, London Macmillan