MBA 681: Case Study on Profit Determination in Monopolistic Markets

This case study delves into profit determination within a monopolistically competitive market, a structure combining elements of monopoly and perfect competition. The analysis explores how firms, characterized by differentiated products and free market entry/exit, determine their profit levels. The study examines the role of demand curves, marginal revenue, and costs (marginal and average total) in shaping a firm's output decisions and profitability in both the short and long run. It also highlights the impact of market entry on demand and the potential for economic profits or losses. The case underscores the significance of consumer demand and innovation in influencing a firm's long-term success within this market structure. The study uses graphical representations to illustrate the concepts and provides a framework for understanding how firms strategize in a competitive environment. Furthermore, the study shows how the firms can generate monopoly power once they are able to gain customer trust and generate a brand value of the products.

Running head: PROFIT DETERMINATION IN MONOPOLISTIC COPMETITIVE MARKET
PROFIT DETERMINATION IN MONOPOLISTIC COPMETITIVE MARKET
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1PROFIT DETERMINATION IN MONOPOLISTIC COPMETITIVE MARKET
Monopolistic Competitive Market
Monopolistic competitive market is a market structure that is a combination of monopoly
and perfectly competitive market such that there aremany producers selling different selling
similar but differentiated products. It is widely used by businesses like hotels, restaurants,
retailing, consumer services andclothing as products are differentiated by price, advertisements,
design, technology and knowledge and are not perfect substituites of each other. There is free
entry and exit in the market with elastic demand and firms have the potential to extract profits
(Parenti, Ushchev, &Thisse, 2017). Therefore, it is important to understand how profits are
determined in monopolistic competition as the market is efficiently growing.
Determination of Profit
As the products are differentiated, firms have inelastic demand and the demand curve is
downward sloping. If the products are less differentiated, elasticity of demand will be more.
Thus, demand curve is the average revenue curve. Marginal revenue curve will have twice the
slope of demand curve and lies inside it (Dhingra and Morrow, 2019). Marginal cost (MC) is
upward sloping. Average total cost (ATC) is U-shaped because there initially when the quantity
is low there is fixed cost, then as the quality goes up AR reduces and reaches a point where ATC
equals MC after which ATC goes up.

2PROFIT DETERMINATION IN MONOPOLISTIC COPMETITIVE MARKET
AR
MR
ATC
MC
Quantity
Price
Qa
Pa
P
A
Figure 1: Short run profit of monopolistic firms
Source: (As created by author)
Firms produce at points where MC intersects the MR because then opportunity cost on
each incremental unit will be greater than the revenue and might lead to economic loss. Quantity
will be at Qa and price will be Pa. The firm will earn an economic profit that is denoted by PaPA
region because Pa exceeds MC and ATC.

3PROFIT DETERMINATION IN MONOPOLISTIC COPMETITIVE MARKET
AR
MR
ATC
MC
Quantity
Price
Qa
Pa
A
Figure 2: Long run profit of monopolistic firms
Source: (As created by author)
Now, other firms will follow the same structure and they will enter the market in the long
run somewhat after 5-6 years that will led to a leftward shift in demand curve and accordingly
slope of MR curve will change as it twice the slope of demand curve.There is zero economic
profits P is equal to ATC (Bertoletti and Etro, 2017). However, firms still must continue
producing as Pa is greater than MC and there is scope for future profitability.

4PROFIT DETERMINATION IN MONOPOLISTIC COPMETITIVE MARKET
AR
MR
ATC
MC
Quantity
Price
Qa
Pa
P
A
Figure 3: Long run loss of monopolistic firms
Source: (As created by author)
However, in the long run which is after a span of over 10-12 years, if more firms are able
to attract the market by marking slightly differentiated profits then demand curve will further
shift leftward that will stiffen the MR curve. Now, ATC exceeds price Pa, although MC is still
lower. However, firms will make loss as denoted by Pa and needs to think about shutting down if
they are unable to attract customers. Now, there is an important factor is consumer demand, if
firms are able to influence markets and keep innovating products then they are like to earn
economic profits in the long run. This is how big firms start with monopolistic competition and
eventually generate monopoly power once they are bale to gain customer trust and generate a
brand value of the products (Bertoletti and Epifani, 2014). The most important thing is that in
monopolistic competition, demand cure is that of monopoly and its impact is like perfect
competition with the entry of more firms. Moreover, time frame cannot be expected in that way

5PROFIT DETERMINATION IN MONOPOLISTIC COPMETITIVE MARKET
because demand is determined by the elasticity of the product that is offered by monopolistic
competitive firm.

6PROFIT DETERMINATION IN MONOPOLISTIC COPMETITIVE MARKET
Reference List
Bertoletti, P. and Epifani, P., 2014. Monopolistic competition: CES redux?. Journal of
International Economics, 93(2), pp.227-238.
Bertoletti, P. and Etro, F., 2017. Monopolistic competition, as you like it. University Ca'Foscari
of Venice, Dept. of Economics Research Paper Series No, 8.
Dhingra, S. and Morrow, J., 2019. Monopolistic competition and optimum product diversity
under firm heterogeneity. Journal of Political Economy, 127(1), pp.196-232.
Parenti, M., Ushchev, P., &Thisse, J. F. (2017). Toward a theory of monopolistic
competition. Journal of Economic Theory, 167, 86-115.