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.