Europa Science & Commerce Academy

Q. No. 17a: Answer:

Define monopolistic completion. Explain equilibrium of firm under monopolistic competition?

Economics Notes

INTRODUCTION: The concept of monopolistic competition was presented by Edward Chamberlain in 1933. Monopolistic Competition refers to a market situation where there are many sellers of differentiated products. CHARACTERISTICS OF MONOPOLISTIC COMPETITION: The following are the characteristics of monopolistic competition.
1) Large Number of Buyers and Sellers:: 2)

3) 4)
5)

6) 7)

In monopolistic competition there are large number of buyers and sellers. No Close Substitutes: The product of each firm can be differentiated in terms of production and distribution techniques, trade mark, etc. Freedom of Entry and Exit: Under monopolistic competition new firms can enter into the industry and existing firms can exit. Nature of Demand curve: The demand curve of affirm under monopolistic competition is downward sloping. It is highly elastic but not perfectly elastic. Control over Price: Under monopolistic competition a firm has limited control over price. Advertisement: Advertisement is the basic tool for firms under monopolistic competition. Firms spend a lot of money on advertisement to attract customers. Stiff Competition: There is a stiff competition among the firms for sale of a particular brand.

EQUILIBRIUM OF A FIRM UNDER MONOPOLISTIC COMPETITION: Short Run: Short run is a time period in which a firm can change its variable factors only. The objective of every firm is to get maximum profit. Condition of Equilibrium Of A Firm: There are two conditions of equilibrium of a firm. a. Necessary Condition MC = MR b. Sufficient Condition MC must cut MR from below. SHORT RUN POSSIBILITIES There are three possibilities of equilibrium in short run. 1) Supernormal Profit 2) Normal Profit 3) Loss
1) SUPERNORMAL PROFIT: Europa Academy Composed & Designed By: Basit butt

Europa Science & Commerce Academy

Economics Notes

A firm will earn supernormal profit when TR>TC. This situation can be explain with the help of diagram. Diagram:
y-axis SMC SAC P Cost & Revenue Curves O Q MR x-axis H Profit T G E AR

In the above diagram output is measured along x-axis while cost and revenues curves are taken on y-axis. Equilibrium takes place at point E where necessary and sufficient conditions are satisfied. Therefore OQ is the equilibrium quantity while OP is determined as equilibrium price. According to diagram: Here AC = GH AR = TP TC = (AC) (Output) TR = (AR) (Output) TC = (GH) (OQ) TR = (TP) (OQ) TC = OQGH TR = OQTP Profit = = TR TC = OQTP OQGH = TPGH Hence supernormal profit of the firm is TPGH. 2) NORMAL PROFIT: A firm will earn normal profit if TR = TC. This can be explain with the help of diagram. DIAGRAM:
y-axis SMC SAC

Cost & Revenue Curves

T AR E MR

x-axis Q Output

According to diagram AC = TP AR = TP TC = (AC) (Output) TR = (AR) (Output) TC = (TP) (OQ) TR = (TP) (OQ) TC = OQTP TR = OQTP Here TR = TC = OQTP Therefore firm is earning normal profit.

Europa Academy

Composed & Designed By: Basit butt

Europa Science & Commerce Academy

3) LOSS: Firm will face losses if TR<TC. This can be explain with the help of diagram. DIAGRAM:
y-axis G Loss T SMC SAC

Economics Notes

H P Cost & Revenue Curves O

AR

MR Q x-axis Output

Here AC = GH AR = TP TC = (AC) (Output) TR = (AR) (Output) = (GH) (OQ) = (TP) (OQ) = OQGH = OQTP Profit = TR TC = OQTP - OQGH Loss = GHTP Here firm is facing loss because total revenue less than total cost. Loss of firm is GHTP. LONG RUN EQUILIBRIUM OF A FIRM Long run is a time period in which a firm can change fixed factors as well as variable factors. If firms are earning supernormal profit new firms will enter in to the industry. In this situation number of sellers will increase. Supernormal profit will convert into normal profit. If firms are facing losses, some of the existing firms leave the industry. In this situation number of sellers decreases. As a result loss will convert in to normal profit. Firm the above discussion it is conclude that firm will earn only normal profit in long run under monopolistic competition. This can be explain with the help of diagram.

Europa Academy

Composed & Designed By: Basit butt

Europa Science & Commerce Academy

Economics Notes
y-axis LMC LAC

Cost & Revenue Curves

T AR E MR

x-axis Q Output

Here AC = TP TC = (AC) (Output) TC = (TP) (OQ) TC = OQTP TC = OQTP Here = TR = TC = OQTP Hence normal profit of the firm is OQTP.

AR TR TR TR TR

= = = = =

TP (AR) (Output) (TP) (OQ) OQTP OQTP

Europa Academy

Composed & Designed By: Basit butt