Page 189 - DECO101_MICRO_ECONOMICS_ENGLISH

Micro Economics

Notes 3. Maximum profit = Normal profit (economic profi t=zero).

4. MR=MC. Here the relevant marginal revenue is derived from the perceived demand
curve.
5. The actual demand curve (or ‘market share’ demand curve) DD cuts AC at the point where
perceived demand curve (dd) is a tangent to AC.
6. Price is greater than MC because price is greater than MR.
7. The equilibrium output is less than the optimum output.

Here also we find that the long run equilibrium output is determined at the level where AC is
falling and therefore the equilibrium output is less than the optimum output, Q . That is, excess
m
capacity exists at long run equilibrium output.

Notes Equilibrium under monopolistic competition results in sub-optimum output
with excess or under utilised capacity and unexhausted economies of scale. This excess
capacity is due to two reasons. First, under monopolistic competition, product

differentiation by competing firms causes the demand curve of the individual firm to slope

downwards. Second, since the number of competing firms is large, every fi rm behaves
independently, with the result that competition through new entry and price variation
continues until every fi rm earns only normal profi ts. The typical fi rm will not reach long
run equilibrium until its demand curve is tangent to AC. In other words, the falling demand
curve and long run tangency solution are the reasons which account for excess capacity
equilibrium. (Also note that at the point of tangency the slope of demand curve is equal
to the slope of the average cost curve. But the slope of falling demand curve is negative.
Hence the slope of cost curve is also negative).

Case Study The Motor Vehicle Repair and Servicing Industry

he typical British small garage is stereotyped as untidy, messy, cluttered with hoists
and equipment, with a few overall-clad figures working to the clatter of tools and

Tblaring radio.
This picture is quite different from that of the early years of the automobile. In those days,
work on the car was the domain of the chauffeur or blacksmith, or the manufacturer if
repairs were beyond both.
This was to change following the Second World War. As the volume of cars grew so the
motor repair sector began to expand, giving employment to the many mechanically trained
ex-servicemen.
The market grew so quickly that there was little chance of erecting entry barriers. For
example, although there were moves to introduce specific (City and Guilds) qualifi cations

for mechanics and thereby impose a degree of restricted entry on the industry, this was
never fully established. The result is to be seen today.
The motor vehicle repair industry has developed into a good example of a monopolistically
competitive industry.
In 2001, it was estimated that the MVR industry in the UK employed just over 170,000
people in about 44,000 businesses. The statistics also show that the industry is still
Contd...

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