Difference Between Short Run and Long Run in Monopolistic Competition

Explain the difference between short-run equilibrium and long-run equilibrium in monopolistic competition.

        Monopolistic competition is a type of market structure characterized by a low concentration of firms, low barriers to entry and exit, firms that are price makers, and heterogeneous products. The short run is a period of time in which at least one factor of production (FoP) is fixed. The long run is a period of time in which all FoPs are variable. Supernormal profit is any profit made over normal profit, which is the opportunity cost of capital and is when a firm is just covering its average costs and covering its average variable costs.

The graphs above show the fast food company McDonalds, which is in a monopolistic competition industry, in the short run and the long run. Firms generally seek to maximize profits or minimize losses where marginal revenue equals marginal costs. As shown in the graph above, McDonalds is making supernormal profit in the short run due to increased revenue following an increase in quantity demanded of their products due to a successful advertisement campaign. Due to McDonalds’ supernormal profit in the short run, other firms may become interested in entering the industry in the long run because there are low barriers to entry in a monopolistic competition market. The increased number of firms in the industry decreases the total market share of each firm, decreasing average revenue and also increases the market supply leading to a consequent decrease in marginal revenue in the long run. The decreased quantity demanded and decreased price of their products causes McDonalds and other firms in the fast food industry to experience normal profits in the long run.[pic 1]

It is also possible that McDonalds and other firms in the industry are earning subnormal profits, profit earned under normal profit, causing firms to shutdown in the short run. If the firms continue to earn subnormal profit in the short run they may decide to exit the industry, leading to an increase in the market share of remaining firms and also decreasing the supply in the market leading to a consequent increase in price. Thus McDonalds and the remaining firms will earn normal profits in the long run due to their increased market shares and the increase in price of their products.