Monopolistic Competition in the Long Run

now, let's consider what happens in the long run for monopolistic competition. So, remember when we discussed the long run for perfect competition, we saw that there was no economic profit. Right? The price equals average total cost in the long run. Well, guess what? In monopolistic competition? The same thing happens, price is gonna equal average total cost. Alright. But it's gonna be a little different. So let's see how it is. So, as with perfect competition, the entry and exit of competitors leads to zero economic profit in the long run. Okay. So you can imagine, just like we said, with perfect competition, when there's profits being made, other people are gonna join the action, right? They're gonna see that there's money and they want to get in on it. Right? So, we're gonna be in some situation, like we see in this left graph where we've got short run profits. Okay. So we've got a demand curve, Our marginal revenue, we've got marginal cost and average total cost. Well, we're gonna see in the short run, right, Well, we want to produce where marginal revenue equals marginal cost, Right? That's right. Here, this quantity. And at that quantity, what's our price and average total cost. Well, let's go up from there and let's find those curves. So here's average total cost. Let's keep going up. And here is price on the demand curve. Right? So our price, our average total cost and this area in here is our profit, right? This is the profit that the firm is making. And that prophet leads other firms to say, hey, we should get in there and start making some money, Right? So as we saw with perfect competition firms are gonna keep entering until those profits disappear. All right. So what we're gonna see here in monopolistic competition? That's a little different. Before we get to the graph, look underneath here on our first bullet point. So what's gonna happen is the entry of firms, right? When we have profits, other firms are going to come in. So say we're a sandwich shop, right? And we're making money. And now other firms want to get in and start making sandwiches as well. So, these entry of firms is going to increase the availability of substitutes, right? There's gonna be other uh, substitute substitutes, there's gonna be other sandwich shops offering similar goods. Right? And what's gonna happen? Well, some of the firm's customers are gonna go to the new firm, right? So they're gonna go try that other sandwich shop and they're gonna say, hey, this place is way better. I'm gonna come here instead. This is gonna be my new regular option. So that's going to shift our demand to the left, right? Because we lost some of our customers. The demand shifted to the left. They prefer the other product now, but it's also gonna make our customers more sensitive to our price changes, Right? So you can imagine now that there's more options to them. They might say, Hey, you increase your price by a dollar. You know, I was willing to pay $5 for your sandwich but $6. I'm just gonna go somewhere else and get a sandwich instead. Right? That means that our demand has become right behind me. It says elastic, it became more elastic, right? The demand becomes more elastic as well, so it shifted to the left and it also becomes more elastic. Alright? And that's what we see back here on the graph. Okay. Um notice that on on the graph here um our demand curve has shifted both to the left right from from our short run model on the on the left graph to the right hand graph for the long run, our demand shifted to the left as well as it became more elastic, right? It's sloped like this a little more and that's gonna keep happening until we reach a point where price equals average total cost, right? Just like we saw in perfect competition, price equals average total cost, and when price equals average total cost. Think about our profit equation right. Our profit equation was price minus average total cost, times quantity, right? Well, if they're equal to each other, if the price is $5 and the average total cost is $5 there's no profit, right? So when price equals average total cost, we have no profit and that's what we see here, right? If we go to our profit maximizing point where marginal revenue equals marginal cost, this quantity right here. Well, check out what's happening on our curves here, our demand curve, our price and our average total cost are equal to each other, right? Price equals average total cost right there. Price equals average total cost. So there's no profit. Right? But this is a little different than what we saw in perfect competition. So in perfect competition, if you'll recall, the long run equilibrium was at the minimum of average total cost. Right? In perfect competition, we had some sort of price level, which was the demand to the firm. That would have looked something like this, right? I'm gonna draw it in real quick. It would have looked something like this, right? And it would have touched at the bottom of the average total cost curve. Right? And that's only possible in perfect competition because we had a flat demand curve, right? Try and think of a curve. Being able to touch touch the average total costs at just one point and be able to touch the minimum point. Right? So remember when we talk about touching at just one point, that's like a tangent to tangent line is what we usually call it in mathematics, where the lines are touching only at one point. So what we see here with our on a regular graph, with our demand and our average total cost, right? That point where our price equals average total cost that we've marked. That's only happening at one point, right? The demand curve is coming in and they touch at one point and then they separate again. Same thing happens in perfect competition with that minimum 80 C. Right? When I had just drawn in there um at this minimum 80 C. In perfect competition. Right? That's where they touch. But imagine how that could be possible with a downward sloping demand curve. There's no way for a downward sloping demand curve, like something like this touching the bottom to only touch it at one point. Right? It kind of looks like it's only touching at one point there. But if we were to extend our average total cost curve, right? If this keeps going right? We we only showing a portion of it if we let it keep going, these are gonna touch again right here. Right? So there's gonna be another point they touch it. They're not tangent. Okay. So remember we need that tangent condition when we draw in our our demand curve and that's where we reach our long run equilibrium where price equals average total cost. Right? Right. Here, where we have no profit but we're not at our minimum average total cost. Okay, So we still have a point where price equals average total cost but it's not the minimum. So what implications does that have? Alright, let's let's look down here in that second bullet point, we see that in the long run the firms do not produce at minimum cost. Right? They do not produce at the minimum cost. Right? Minimum cost would be the minimum of the A. T. C. Curve. Right? That is the minimum cost. So only a firm facing a horizontal demand curve just like we saw something like in perfect competition. I'm gonna put perf comp for perfect competition. That's the only one that can achieve that minimum 80. Well that means we have this idea of excess capacity, excess capacity right? The firm is not reaching its minimum average total cost they're producing at some point before that. Right? So they if they were able to expand their production they would actually reduce their cost and that's a good thing for society. But they're trying to maximize their profit, not reduce their cost. Right? They want the maximum on a profit. And that's gonna come up at that point where marginal revenue equals marginal cost. And that's always gonna lead us to have some point where we have excess capacity and that excess capacity. What I mean is from our quantity, we're producing this profit maximizing quantity. I'm gonna put PM for profit maximizing and right here. Right this might be the minimum of the A. T. C. Well, this is the perfect competition quantity, right? That's the efficient quantity where we reach the minimum of the A. T. C. So you can imagine that everything in between here is our excess capacity. Right. Okay. So that's one condition with the monopolistic competition is that we don't reach that minimum 80 C. So we have excess capacity. Okay, So what did we learn here? We learn that those profits are eliminated in the long run, even though you can make short run profit, the entry and exit of other firms entry, if there's profit exit, if there's losses Is always gonna lead us to a situation where the price equals average total cost in the long run. Okay. And the other thing there with the excess capacity, that is because we're not at our minimum 80 C. cool. Let's go ahead and do some practice and we'll move on in the next video.

All right. I just want to make one more quick point before we move on with monopolistic competition. So, we saw in the long run there's no economic profit to be made. Right? So, you might think, why do these firms stay in business? Or how has a firm like Mcdonald's or Starbucks stayed relevant and stayed profitable? Right. Well, the trick is that they have to constantly differentiate their product, right? If they were not to keep differentiating their product, they would reach a point where other firms are eating up all their profits and they're not making profit anymore. So think about Starbucks when they first breached the market, they were making tons of money selling premium coffee, right? And then other firms started coming in. I know even here in Miami, I see other coffee shops that are exactly the same, they set up with the same little deli, they've got in the front with the little sandwiches, they've got the same choices of coffee, ice coffee, frappuccino type things, right? They've set up that same business. So then what did Starbucks do? Well, they started selling other products as well, right. They started selling t they started selling coffee mugs, they started a loyalty club, right? They start all these different things to differentiate their product and keep themselves making profit. Right? So the trick here is to keep differentiating your product to keep you in that short run profitable state, right? If you become idle at one point, other firms are just gonna come in replicate what you're doing and eat up all your profit. All right, So that's just a quick point of how firms do end up staying profitable in the long run. Alright, let's go ahead and move on to the next topic.

New firms will enter a monopolistically competitive market if

• A. Marginal revenue is greater than marginal cost
• B. Marginal revenue is greater than average total cost
• C. Price is greater than marginal cost
• D. Price is greater than average total cost

What is true of a monopolistically competitive market in long-run equilibrium?

• A. Price is greater than marginal cost
• B. Price is equal to marginal revenue
• C. Firms make positive economic profits
• D. Firms produce at the minimum of average total cost