Long run equilibrium or price determination under monopolistic or imperfect competition:
(Long Run Zero Economic Profits)
In the long run, the firms are able to alter the scale of plant according to the changed conditions of demand for a product in the market. They can also leave or enter the industry. If the firms are earning abnormal profits in the short run, then new firm will enter the ‘product group’ (industry). The tendency of the new firms to enter the industry continues till the abnormal profits are competed away and the firm’s economic profits become zero.
In case of the monopolistic or imperfect competitive firms, realize losses in the short run, then some of the firms will leave the industry. The exit of the firm continues till zero economic profits are restored with the operating firms.
In the long run, there are no entry barriers for the new firms. The incoming firms install latest machinery and try to differentiate their products from those of the established firms. The old firms operating with the used machinery try to match up with the new entrants by improved variety of products in their group. They increase expenditure on advertisement and on other sales promotional measures. They employ more qualified staff for making technical improvement in their products.
Since all the firms for their existence incur additional expenditure for improving the quality of the products, the cost curves of all the firms move up. Due to entry of new firms in the industry and higher costs of production, the output of each competing firm is reduced. There is, therefore, a waste in the economic resources of the country.
The equilibrium price and output in the long-run is explained with the help of a diagram.
In the figure (17.3), the higher shifted long run marginal cost curve intersects the higher shifted marginal revenue curve at point M. The firm at this raised equilibrium point, produces the reduced level of output OK.
It sells this output at price TK as at point T. LAC is a tangent to the demand or average revenue curve at its minimum point. The total revenue of the firm is equal to the area OETK. The total costs of the firm are also equal to the area OETK. The firm is earning only zero or normal economic profits.
As the monopolistic competitive firm sets a price higher than that minimum average cost in the long-run, the firm therefore produces a smaller output. Since all the firms in the product group produce less at higher price, there is, therefore, an apparent waste of resources and exploitation of the consumers.
The advocates of monopolistic competition are of the opinion that if consumers get differentiated products at slightly higher prices (than with no choice under perfect competition), the consumers are then not exploited. There is no wasting of resources either, as the consumer’s welfare increases with the product differentiation.