Monopolistic Competition — Short Run and Long Run
Diagram showing monopolistic competition in the short run (supernormal profit) and long run (normal profit), with the firm facing a downward-sloping demand curve.
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This diagram illustrates how monopolistic competition evolves from short-run to long-run equilibrium, showing the key difference between temporary supernormal profits and long-run normal profits. In the short run, firms can earn supernormal profits when price exceeds average cost, but these profits attract new competitors into the market. The entry of new firms shifts each existing firm's demand curve leftward and makes it more elastic, continuing until supernormal profits are eliminated and firms earn only normal profit in long-run equilibrium. This demonstrates the self-correcting mechanism of monopolistic competition.
Key points
- Short-run equilibrium occurs where MR = MC, potentially allowing supernormal profits if AR > AC at this output level
- Supernormal profits in the short run attract new firms to enter the market due to low barriers to entry
- New entrants shift existing firms' demand curves left and make them more elastic as consumers have more substitute products
- Long-run equilibrium is achieved when the demand curve is tangent to the AC curve, eliminating supernormal profits
- In long-run equilibrium, firms produce at less than minimum efficient scale, creating excess capacity
Exam tip
Always clearly label the shift from short-run to long-run equilibrium by showing how new firms entering the market causes the demand curve to shift left until supernormal profits are eliminated. Examiners are impressed when students explicitly explain that the demand curve becomes more elastic in the long run due to increased competition from new entrants.
Common mistakes
Students often confuse the shift of the demand curve with movement along it, failing to understand that new firms entering causes the entire demand curve to move leftward. Many also incorrectly assume firms make losses in the long run, when they actually earn normal profit (zero economic profit).
Exam board notes
All major exam boards treat this diagram identically, though Edexcel places slightly more emphasis on explaining the excess capacity that results from long-run equilibrium. AQA and OCR focus equally on both the adjustment process and the final equilibrium position.
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