Monopolistic Competition

Economic Profit for Monopolistic Competition

• short run:

  • firms can earn economic profit when price > atc at quantity produced

  • firms can also have losses when price < atc

• long run:

  • if firms earn profit → new firms enter

    • more choices for consumers

    • demand for each existing firm’s product falls (demand curve shifts left)

  • if firms have losses → firms exit

    • less choices

    • demand for remaining firms rises (demand curve shifts right)

  • in the long run, firms make zero economic profit (price = atc)

    • still making normal profit (enough to stay in business)

• key characteristics:

  • firms have some pricing power (due to differentiation)

  • demand curve = downward sloping

  • products are close substitutes but not perfect substitutes

  • examples: restaurants, clothing brands, salons

• graph features:

  • price is above marginal cost (p > mc)

  • not producing at minimum atc → excess capacity (small inefficiency)