# Monopolistic Competition

## 2. Short Run

 SR problem choose q to maximize its profit π = pd(p) - c(q), where d(p) is SR demand curve. d(p) is based on the assumption that other monopostically competitive firms set prices independently. Each firm's market share is 1/N. Sometimes this is called the proportional demand curve (SR demand curve). First order condition π' = MR - c'(q) = 0. SR profit Short Run: Not in the sense that capital is a fixed input, but in the sense that the number of firms is fixed. In the SR, a monopolistically competitive firm can earn positive economic profits, as shown by the red tinted area. However, in the LR, free entry ensures that economic profits vanish.

## 3. Entry and LR equilibrium

 Effect of entry Market demand is given by Q = D(p). Each firm has a small share of the market. The proportional demand curve facing a typical firm is q = D(p)/n, where n is the number of monpolistically competitive firms. example If the market demand is given by Q = 100 - 10p, then the slope of the market demand curve is dQ/dp = - 10. If there are 20 firms in the market, the proportional demand curve in Long Run equilibrium is q*(p) = D(p)/n = 5 - 0.5p, and the slope of the proportional demand curve is dq*/dp = -0.5. entry and exit If the typical firm earns positive profits, the number of firms increases. The proportional demand curve q = D(p)/n shrinks, rotating q(p) clockwise, as show below. If the typical firm incurs a loss, firms exit and the proportional demand curve rotates counterclockwise. LR equilibrium The number of firms increases or decreases until the typical firm earns zero profit. excess capacity Ideal output is that output which is associated with the minimum point of the LAC curve. A monopolistically competitive firm does not operate there in LR equilibrium. Chamberlain argued for treating the higher production cost due to excess capacity as a social loss. However, product differentiation is socially desirable.