Q.Explain the main features of monopolistic competition and describe how a firm reaches long-run equilibrium under it.

Monopolistic competition mixes many-firm competition with the price control that product differentiation gives.

Features of monopolistic competition.

1. Large number of sellers, each acting independently.
2. Product differentiation — goods are close but not perfect substitutes, differing in brand, quality or packaging. This is the defining feature and the source of each firm's limited price control.
3. Free entry and exit in the long run.
4. Selling costs — advertising and sales promotion to build brand loyalty.
5. A downward-sloping but highly elastic AR curve, because close substitutes are available.

Short-run equilibrium. Each firm maximises profit where $MR = MC$; depending on AC it may earn supernormal profit, normal profit or a loss.

Long-run equilibrium. Supernormal profits attract new firms; each existing firm's share of demand falls and its AR curve shifts left until it becomes tangent to the AC curve. Losses drive firms out until the same tangency is reached from below. At long-run equilibrium therefore

so the firm earns only normal profit. Because the AR curve slopes downward, tangency occurs to the left of the minimum point of AC, leaving the firm with excess capacity — it produces less than the least-cost output. …

Confusing monopolistic competition with monopoly. Here there are many firms and free entry, so long-run profit is only normal (unlike monop …