Question

Both monopolistic competition and perfectly competition are market structures where firms earn normal profits in the long run, but with a difference.

a. Using a single diagram, show the equilibrium price,output and average costs for both markets in the long run.
b. Which is the common feature of both markets that makes the sellers earn only normal profits in the long run?

Answer 1

(A) perfect competition

meaning: It is a market situation in which there are large number of buyers and sellers where homogenous goods are produced and uniform price prevails in the market.

diagram in long run:

HERE: 1) P refers to equilibrium price , Q refers to equilibrium output quantity and E refers to Equilibrium point .

2) LAC - Long run average cost and LMC - long run marginal cost

(NOTE : It will be impressive if you show LMC curve too )

(A) Monopolistic Competition

meaning: It is a market situation in which features of both monopoly and perfect competition are present.

here there are many number of sellers selling closely related but differential products. for example frims producing different brands of toothpaste like colgate, close-up, pepsodent etc .

diagram in long run:

HERE: 1) P refers to equilibrium price , Q refers to equilibrium output quantity and E refers to Equilibrium point .

2) LAC - Long run average cost and LMC - long run marginal cost

3) LAM - Long run average revenue and LMR - long run marginal revenue

(B) COMMON FEATURE

the common feature in both markets that help seller earn only normal profit in the long run is free entry and free exit of the firms.

The new firms are free to  enter the market at any time they like , similarly existing firms can leave the market at any time they like . This ensures that there are neither abnormal profit nor abnormal losses by the firm in the long run.

suppose the firms are earning abnormal profit , a new firm will enter into the industry. This will lead to increase in the supply and thus leads to fall in equilibrium price. This process continues till normal profits are earned .

suppose the firms are incurring abnormal losses, some firms exit from the industry. This will lead to decrease in the supply and thus leads to rise in equilibrium price. This process continues till normal profits are earned.