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Unit 12: Monopolistic Competition

of output. It is given by a ratio of total market demand divided by the number of fi rms. The Notes

larger the number of firms in the market, the smaller the absolute market share of each fi rm. The
position of DD, i.e., its distance from the Y-axis therefore depends upon the number of fi rms in
the market. The actual demand curve DD will shift nearer to the Y-axis as the number of fi rms

increases and will move further away from the Y-axis as the number of firms decreases. That is,

DD will shift towards the left as new firms enter the industry and it will shift towards right when

the existing firms leave the industry.
As shown in Figure 12.3 the initial actual demand curve is shown by DD . It cuts the AC curve
1
at point J. Let dd be the initial perceived demand curve cutting DD at point B . As explained
1
1
1
in above, competition among firms through price variation will continue until the perceived

demand curve dd becomes dd , which is tangent to AC at point E. Point E shows price to
1 2
be = OP . However, point E is not situated on the actual demand curve DD . Hence, the fi rm fi nds
2
1
that corresponding to point E, the actual demand on DD is P R. Now point R on DD is above
2
1
1
the AC curve. Therefore output P R indicates super-normal profits shown by area P RGC . These

2 2 2

supernormal profits induce new firms to enter the industry. As the number of fi rms increases

the absolute market share of each decreases and the actual demand curve DD shifts towards the
1
left.
This process will continue till DD shifts to the position of DD which intersects the AC curve
1 2
at point E where the perceived demand curve dd is a tangent to AC. At this point profi ts are
2
normal on the basis of perceived demand curve dd as well as on the basis of actual demand
2
curve DD . That is, actual demand and perceived demand are equal when profits are normal.

2
The point of tangency between dd and AC is at point E where DD cuts AC. Here the long run
2
2
equilibrium output is Q and price is P . 2
2
Figure 12.3
Price, MR,
AC, MC
D
D
AC
d MC
d B 1
E R d 1
G J
P 2
C 2
S K D 1 N
0 Q 2 Q 1 D 2 mr 2 Q M d 2 Output
Here the competition through price variation is shown by the downward shift in the perceived
demand curve along the actual demand curve. (From position dd to position dd , which is
1 2
tangent to AC at point E). And the competition through new entry is shown by the shift in the
position of actual demand curve (DD shifts to the position of DD ) which intersects AC at the
1
2
point of tangency of dd and AC, i.e., at point E.
2
Under monopolistic competition, when there is competition through price variation as well as

new entry (or exit), the long run equilibrium of the firm will be reached when following conditions
are satisfi ed.
1. Perceived demand curve dd is 2 tangent to AC.
2
2. Price is equal to AC.
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