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Microeconomic Theory

Notes 14.5 Long-Run Equilibrium in Monopolistic Competition

Long-term is that duration of time in which firms can change level of their plants, new firms can enter
into the market and old firms can leave the market. It should be kept in mind that products
differentiated in monopolistic competition are not similar. Chamberlin had used the word product
group at the place of industry to those firms which produce differentiated product. There is freedom
of entry and exit of firms in ‘product group’. Because there is freedom of entry and exit of firms in
monopolistic competition so all the firms obtain only normal profit producing at higher level of profit
in the situation of long-run equilibrium. It is assumed that demand and cost curves for all products
are uniform throughout the group. In long-run, in the condition of monopolistic competition (i) firms
do not earn super normal profits (ii) firms do not have loss (iii) firms earn only normal profits. These
can be described as follows—
(1) Firms will not Earn Super Normal Profits: If in the situation of monopolistic competition,
firms earn super normal profits so new firms will enter into the product group. They will
produce nearby substitutes. When new firms attract customers of recent firms then demand of
production of recent firms will become less. As a result, cost will decrease. Entry of new firms
will continue in the market till when firms have not been earning the super normal profits.
In other words, in long-run due to the freedom of entry of firms super normal profits are not
earned. Yet, every firm has monopoly in its differentiated product but due to the competition
of conflicted firms producing nearby substitutes they are compelled to produce only in the
situation of normal profits.
(2) Firms will not incur loss: No firm will incur
loss in long-run. If any firm is getting loss Why only normal profits are obtained
in long-run then it will be better to stop in long-run?
their production and exit from the group. The reason is that like perfect competition there is
This will decrease the level of production, freedom of entry and exit to firms in monopolistic
accomplishment will be less in comparison competition also.
of demand, cost will increase and firms will
earn normal profits again.
The cost determination in long-run can be clarified by Fig. 14.4.
In Fig. 14.4 LAC is long-run average cost curve and LMC is long-run marginal curve. AR is lead average
and MR is marginal lead curve. MR and MC at point E are equal to each other. Therefore, it will be
equilibrium point. OM will be produced on this point, which costs OP(=AM). Average revenue curve on
equilibrium production OM is touching long-run average cost curve at point A. So, in the equilibrium
condition, cost and long-run average cost (AR = LAC) are equal to each other. Therefore, firms are
earning only normal profits. There will be maximum profits of LAC and AR at ‘A’, Point of Tangency.
The reason is that on any other cost average cost (AC) is more than average revenue (AR) of long-run
average cost curve (AR) so firm will incur loss. Due to the normal profits obtained by the firm, there
will be no encouragement for the entry of new firms in the group and no reason for exit of old firms
from the group.
By viewing the Fig. 14.4, one more important thing is cleared that firm cannot use its fullest capacity
on equilibrium point means production level of firm on equilibrium point is not optimum. The
reason is that the average revenue curve falling down cannot touch U-shaped long-run average cost
curve to its optimum point. Average revenue curve is parallel to OX-axis in perfect competition, so
it touches average cost on its optimum point on equilibrium point. But in monopolistic competition
AR curve because of its negative slope touches U-shaped LAC curve to its point of highest cost,
like it is known from Fig. 14.4. Therefore, in monopolistic competition long-run average cost is not
optimum on equilibrium point. That’s why firm production on equilibrium point is also optimized.

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