Short run equilibrium and price determination under monopolistic or imperfect competition:
Imperfect or monopolistic competition refers to the market organization where there are a fairly large number of firms which sell somewhat differentiated products.
A single firm in the product group (industry) has little impact on the market price. However, if it reduces price, it can expect a considerable increase in its sales. The firm may also attract buyers away from other firms by creating imaginary or real difference through advertising, branding and through many other sales promotion measures (non-price competition).
If the firm raises its price, it will not lose all its customers. This is because of the fact that the product is differentiated from competing firms due to price and non-price factors. The demand curve (AR curve) of the monopolistic firm is therefore, highly elastic and is downward sloping. As regards the marginal revenue curve, it slopes downward and lies below the demand curve because price is lower of all the units to sell more output in the market.
Determination of Price and Output (Profit or Loss):
In the short run, the number of firms in the ‘product group’ remains the same. The size of the plant of each firm remains unaltered. The firm whether operating under perfect competition, or monopoly wants to maximize profits.
In order to achieve this objective, it goes on producing a commodity so long as the marginal revenue is greater than marginal cost. When MR = MC, it is then in equilibrium and produces the best level of output (profit).
If a firm produces less than or more than the MR = MC output, it will then not be making maximum profit.
In the short run, a monopolistic competitive firm may be realizing abnormal profits or suffering losses. If it is earning profits, no new firms can enter the industry in the short-run. In case, it is suffering, losses but covering full variable cost, the firm will continue operating so that the losses are minimized. If the full variable cost is not met, the firm will close down in the short-run.
The short run equilibrium with profits and short run equilibrium with losses of a monopolistic competitive firm are explained with the help of two separate diagrams as under:
In the figure (17.1), the downward sloping demand curve (AR curve) is quite elastic. The MR curve lies below the average curve except at point N. The SMC curve which includes advertising and sales promotional costs is drawn in the usual fashion. The SMC curve cuts the MR curve from below at point Z. The firm produces and sells an output OK, as at this level of output MR = MC. The firm sells output OK at OE/KM per unit price. The total revenue of the firm is equal to the area OEMK, whereas the total cost of producing output OK is OFLK. The total profits of the firm are equal to the shaded rectangle FEML. The firm earns abnormal profits in the short run.
If the demand and cost situations are not favorable in the market, a monopolistic competitive firm may incur losses in the short run. The short-run equilibrium of the firm with losses is explained with the help of a diagram.
In the Figure (17.2), marginal cost (SMC) equates marginal revenue MR curve from below at point Z. The firm produces output OK and sells at OF/KT per unit-price. The total receipt of the firm is OFTK. The total cost of producing output OK is equal to OEMK. The firm suffers a net loss equal to the area FEMT on the sale of OK output.