Determination of Equilibrium price

Determination of Equilibrium price and output under monopolistic competition:

The monopolistic competitive firm will come to symmetry on the principle of equalizing MR with MC. Each and every firm will select that price and output where it will be maximizing its profit. Figure below shows the symmetry of the individual firm in short period.

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Figure: Short Period Equilibrium of a Monopolistic competitive firm with Profit

MC and AC are the short period marginal and average cost curves. The sloping down average revenue and marginal revenue curves are illustrated as AR and MR. The equilibrium point is E where MR = MC. The equilibrium output is OM and the price of the product is fixed at OP. The difference among average cost and average revenue is SQ. The yield is OM. Therefore, the supernormal profit for the firm is illustrated by the rectangle PQSR. The firm by generating OM units of its commodity and selling it at a price of OP per unit understands the maximum gain in the short run.

The various firms in monopolistic competition might be making either abnormal profits or losses in the short period based on their costs and revenue curves.

In long run, when the existing firms earn super normal profit, the entry of new firms will decrease its share in the market. The average revenue of the product will come downward. The demand for factors of production will raise the cost of production. Therefore, the size of the profit will be decreased. When the existing firms acquire losses in the long-run, some of the firms will leave the industry raising the share of the existing firms in the market. Since the demand for factors becomes less, the price of factors will come downward. This will decrease the cost of production that will raise the profit earned by the accessible firm. Therefore under monopolistic competition, every existing firm will earn normal gain in the long run.

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