5 Steps to a 5 AP Microeconomics, 2014-2015 Edition

Long-Run Adjustment

With easy entry and exit into the monopolistically competitive industry, short-run positive

profits like those in Figure 9.14 are not going to last for long. As new firms enter this indus-

try, the market share of all existing firms begins to fall. Graphically we see this as a leftward

shift in the demand curve. As the price begins to fall, the profit rectangle begins to shrink.

Entry stops when profits are zero and P=ATC, or when the demand curve is just tangent

to ATC. This adjustment is seen in Figure 9.15

“What About Advertising to Maintain Profits?”

Because easy entry of competitors drives profits down to breakeven levels, monopolistically

competitive firms typically engage in extensive amounts of advertising to slow down, and

even reverse, declining market share. This advertising is realistically only a short-run “fix,”

as there is no reason to believe that barriers to entry suddenly emerge to prevent the even-

tual return to breakeven profit levels.

Efficiency and Excess Capacity

In long-run monopolistic competition, the firm earns P=0, a characteristic shared by the

perfectly competitive firm. But because of the differentiated products, P>MR =MC, alloca-

tive efficiency is not achieved. The deadweight loss is the shaded area in Figure 9.15. Though

the firms are breaking even, they are not operating at the minimum of ATC; productive effi-

ciency is also not achieved. The difference between the monopolistic competition output Qmc

and the output at minimum ATC is referred to as excess capacity. Excess capacity is under-

used plant and equipment that is the result of producing at an output less than that which

minimizes ATC. The market is overpopulated with firms, each producing enough to break

even in the long run, but so many firms means that each produces below full capacity.

Market Structures, Perfect Competition, Monopoly, and Things Between ‹ 133

Quantity

D

AT C

MC

Qmc

$

MR

Pmc = ATC

Qatc

Excess capacity

Deadweight Loss

Figure 9.15

• Qmc<Qc


• Pmc>Pc


• Pmc>MC so monopolistic competition is not allocatively efficient.


• Deadweight loss exists, but not as much as with monopoly.


• Pm>minimum ATC so monopolistic competition is not productively efficient.


• Pmc=0 in the long run.


• Excess capacity is Qatc-Qmc.

TIP