Page 375 - The Principle of Economics

CHAPTER 17 MONOPOLISTIC COMPETITION 381
MC
ATC
Demand
MR
Price
P = ATC
0
Profit-maximizing quantity
Quantity
Figure 17-2
A MONOPOLISTIC COMPETITOR
IN THE LONG RUN. In a monopolistically competitive market, if firms are making profit, new firms enter, and the demand curves for the incumbent firms shift to the left. Similarly, if firms are making losses, old firms exit, and the demand curves of the remaining firms shift to the right. Because of these shifts in demand, a monopolistically competitive firm eventually finds itself in the long-run equilibrium shown here. In this long-run equilibrium, price equals average total cost, and the firm earns zero profit.
To sum up, two characteristics describe the long-run equilibrium in a monop- olistically competitive market:
N As in a monopoly market, price exceeds marginal cost. This conclusion arises because profit maximization requires marginal revenue to equal marginal cost and because the downward sloping demand curve makes marginal revenue less than the price.
N As in a competitive market, price equals average total cost. This conclusion arises because free entry and exit drive economic profit to zero.
The second characteristic shows how monopolistic competition differs from mo- nopoly. Because a monopoly is the sole seller of a product without close substi- tutes, it can earn positive economic profit, even in the long run. By contrast, because there is free entry into a monopolistically competitive market, the eco- nomic profit of a firm in this type of market is driven to zero.
MONOPOLISTIC VERSUS PERFECT COMPETITION
Figure 17-3 compares the long-run equilibrium under monopolistic competition to the long-run equilibrium under perfect competition. (Chapter 14 discussed the equilibrium with perfect competition.) There are two noteworthy differences be- tween monopolistic and perfect competition: excess capacity and the markup.
Excess Capacity As we have just seen, entry and exit drive each firm in a monopolistically competitive market to a point of tangency between its demand