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(B) Equilibrium and Profits: When the product is differentiated an individual firm has some capacity to influence market conditions. It can exert a degree of control over price and output sold. Equilibrium of a firm has been explained in Figure 50.

In the figure, we notice two demand curves dd and DD which need some explanation. Both are demand or average revenue curves. They differ in certain respects which are as follows:

i) dd is the demand curve of a firm which differentiates its product. As a result of this the firm expects to sell a larger quantity. The dd curve is flatter and more flexible. However, the firmís expectations may not be fulfilled.

ii) In the market the firm faces competition from its rivals. Its actual share in the market is smaller than what it had expected. Such a market share of the firm is shown by the DD curve. This curve is steeper and less flexible.

The firm attains equilibrium at a point e which is a point of intersection of the dd and DD curves. In the equilibrium position a firm sells output Q at price P. The total revenue of the firm is equal to the area OQeP. In order to find the profit of the firm we have to introduce the cost curve and work out the total cost of production. For this purpose, Chamberlin has used LAC, the Long run Average cost Curve of the firm. This is because of the fact that the firmís adjustments and the rivalsí reaction process is time-consuming. It can be completed only in the long run. The vertical line eQ intersects the cost curve at point S which determines average cost of producing output Q. The total cost that the firm has to bear in producing output Q units is equal to the area OQSC. The difference between total revenue and total cost shows extra profits that the firm earns. These are equal to the area CSeP.

Profits TR - TC = OQeP  OQSC = CSeP

Under monopolistic competition the conditions that matter are the demand curve and the average revenue of the firm. Any reference to marginal revenue and marginal cost is not necessary for such equilibrium.

(C) Long run Normal Profits: When a firm has differentiated its product successfully it earns extra profits by selling more output and charging a higher price. These profits may not continue in the long run. The reason is: when one firm makes extra profits other firms are also induced to differentiate their products. Moreover, outside firms will also start entering the market. Such reactions on the part of the rivals cause a firmís demand curve dd to slide downwards as d1d1in Figure 51.

It will continue to slide until it becomes tangential to LAC at point e1 as seen in Figure 51. This is a new long run equilibrium point. Market share demand curve also shifts to the left from DD to D1D1 and passes through point e1. In this new equilibrium position the firm sells a smaller output Q1 at a lower price P1. Its total revenue and total cost are both equal and of the size OQ1e1P1. Thus extra profits have been competed with. Still this may not be a stable equilibrium solution because individual firms are free to undertake fresh rounds of product differentiation. This may renew the whole process.

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Index

13.1 Market Imperfections
13.2 Equilibrium under Monopolistic Competition

Chapter 14

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