In monopolistic competition, firms decide on an output quantity that balances marginal revenue (MR) and marginal cost (MC) in order to maximize their profits. The price the company may charge for its goods will, however, be higher than its marginal revenue due to the downward sloping demand curve. The quantity that would maximize profit will therefore be less than the number that would also maximize revenue. The price that maximizes profits will be less than the average total cost but more than the marginal cost. This indicates that businesses engaged in monopolistic competition will see short-term positive economic profits. However, the demand curve facing the incumbent firm will move leftward as new businesses can enter the market and offer comparable items, lessening its market strength and its capacity to charge a premium price. Entry into the Market and Economic Gains
Positive economic profits generated by monopolistic competition firms will entice new businesses to enter the market. New businesses will increase the supply of goods, which will cause the demand curve to shift to the left and lower the prices that businesses can set. As a result, the market will get more competitive and the economic profitability of the existing company would gradually decline.
Long-term, new businesses will continue to enter the market until there are no longer any economic profits. Firms under monopolistic competition will thus only be making typical profits, which will only be sufficient to cover their opportunity costs. Each company will have some level of market power since the items are differentiated, but this strength will be constrained by the availability of close replacements.
Economic Losses Associated with Monopolistic Competition
Some businesses in monopolistic competition will leave the market when they suffer a financial loss. The reduction in supply will cause the demand curve to move to the right and raise the maximum price that any firm can charge. As a result, the market will become less competitive and the financial losses suffered by the remaining businesses will diminish over time.
Long-term, enterprises will continue to leave the market until there are no more economic losses. Firms under monopolistic competition will thus only be making typical profits, which will only be sufficient to cover their opportunity costs. Each company will have some level of market power since the items are differentiated, but this strength will be constrained by the availability of close replacements.
In monopolistic competition, firms select the amount of output that will maximize their profits by balancing marginal income and marginal cost. When businesses make a profit, new businesses will enter the market and weaken the position of established businesses. Businesses that experience financial losses will leave the market, giving the remaining businesses more clout in the market. Businesses under monopolistic competition will ultimately only generate normal profits—just enough to pay their opportunity costs.