Short on time? This page is the recap. For the graphs and worked examples, use the full study guide.
Recap
- Monopolistic competition: many small firms selling differentiated products (close but not perfect substitutes), with easy entry and exit.
- Each firm faces a downward-sloping, fairly elastic demand curve, so MR lies below demand.
- Firms compete with advertising, branding, quality, location and service as well as price. Advertising aims to raise demand and make it less elastic; it raises ATC, not MC.
- Short run: produce where MR = MC, read P from demand, compare P with ATC: profit, loss or zero.
- Long run: entry (if profits) or exit (if losses) shifts each firm’s demand until it is tangent to ATC: P = ATC, zero economic profit.
Key relationships
| Situation | What happens to each firm’s demand | Result |
|---|---|---|
| Short-run profit (P > ATC) | firms enter; demand shifts left, becomes more elastic | profit falls to zero |
| Short-run loss (P < ATC) | firms exit; demand shifts right, becomes less elastic | loss shrinks to zero |
| Long-run equilibrium | demand tangent to ATC at the MR = MC quantity | P = ATC > MC |
| Measure | How to find it |
|---|---|
| Profit or loss | (P − ATC) × Q at the MR = MC quantity |
| Excess capacity | quantity at minimum ATC − quantity produced |
| Deadweight loss | triangle between demand and MC, from the quantity produced to where they meet |
Long-run comparison
| Perfect competition | Monopolistic competition | |
|---|---|---|
| Profit | zero | zero |
| P and MC | P = MC | P > MC (allocatively inefficient) |
| Output and minimum ATC | at minimum ATC | below it (excess capacity) |
Mistakes to avoid
- Showing long-run economic profit: free entry removes it.
- Placing the tangency at minimum ATC: it is on the falling part of ATC.
- Drawing the tangency where MC crosses ATC.
- Reading the price from MR instead of demand.
- Saying advertising raises MC: it is a fixed cost, so it raises ATC.
- Forgetting the shutdown check: a loss-making firm stays open in the short run if P ≥ AVC.
Quick self-check
- A firm produces 50 units where MR = MC; P = $9 and ATC = $7. Profit? What happens next? ((9 − 7) × 50 = $100 profit; firms enter and its demand shifts left until P = ATC.)
- In long-run equilibrium, is P greater than, equal to or less than MC? (Greater than MC.)
- Why is there excess capacity in the long run? (Demand slopes down, so it touches ATC to the left of minimum ATC.)
- Which is productively efficient in the long run: perfect competition or monopolistic competition? (Perfect competition.)
Next: practice questions.