AP_Krugman_Textbook

enough time has elapsed for firms to enter or exit the industry. To analyze monopolis-

tic competition, we focus first on the short run and then on how an industry moves

from the short run to the long run.

Panels (a) and (b) of Figure 67.1 show two possible situations that a typical firm in a

monopolistically competitive industry might face in the short run. In each case, the

firm looks like any monopolist: it faces a downward-sloping demand curve, which im-

plies a downward-sloping marginal revenue curve.

We assume that every firm has an upward-sloping marginal cost curve but that it

also faces some fixed costs, so that its average total cost curve isU-shaped. This as-

sumption doesn’t matter in the short run; but, as we’ll see shortly, it is crucial to under-

standing the long-run equilibrium.

In each case the firm, in order to maximize profit, sets marginal revenue equal to

marginal cost. So how do these two figures differ? In panel (a) the firm is profitable; in

panel (b) it is unprofitable. (Recall that we are referring always to economic profit and

not accounting profit—that is, a profit given that all factors of production are earning

their opportunity costs.)

In panel (a) the firm faces the demand curve DP and the marginal revenue curve

MRP.It produces the profit-maximizing output QP,the quantity at which marginal

revenue is equal to marginal cost, and sells it at the price PP.This price is above the av-

erage total cost at this output, ATCP.The firm’s profit is indicated by the area of the

shaded rectangle.

In panel (b) the firm faces the demand curve DUand the marginal revenue curve

MRU.It chooses the quantity QUat which marginal revenue is equal to marginal cost.

660 section 12 Market Structures: Imperfect Competition

DP

Profit

Loss

MRP

ATC

(a) A Profitable Firm (b) An Unprofitable Firm

QP

PP

Quantity

Price,

cost,

marginal

revenue

ATCP

DU

MRU

MC

ATC

QU

PU

Quantity

Price,

cost,

marginal

revenue

ATCU

Profit-maximizing quantity Loss-minimizing quantity

MC

figure 67.1 The Monopolistically Competitive Firm in the Short Run

The firm in panel (a) can be profitable for some output quantities:

the quantities for which its average total cost curve, ATC,lies below

its demand curve, DP. The profit-maximizing output quantity is QP,

the output at which marginal revenue, MRP,is equal to marginal

cost, MC.The firm charges price PPand earns a profit, represented

by the area of the green shaded rectangle. The firm in panel (b),

however, can never be profitable because its average total cost

curve lies above its demand curve, DU,for every output quantity.

The best that it can do if it produces at all is to produce quantity

QUand charge price PU.This generates a loss, indicated by the area

of the yellow shaded rectangle. Any other output quantity results in

a greater loss.