Question

Graph a monopolistically competitive firm in both (i) SR, and (ii) LR.

Answer 1

In short run, a monopolistic competitive firm maximizes profit by equating its Marginal revenue (MR) with marginal cost (MC). Assuming it earns positive economic profit in short run, new entry occurs until in the long run, all firms earn zero economic profit by producing an output for which price equals average total cost (ATC).

In following graph, panel (A) depicts short run equilibrium where equilibrium is at point E where MR intersects MC with price P0 and output Q0. Short run profit equals area P0ABC. Panel (B) depicts long run equilibrium where MR intersects MC at point F with price P0 and output Q0. Since ATC touches demand curve at point G, Price equals ATC and long run profit is zero.