10.4: MR, MC and Demand Curve under Monopolistic Competition

Under monopolistic competition, a market structure is characterized by many firms selling differentiated products. The Demand Curve in monopolistic competition is downward sloping, reflecting the negative relationship between price and quantity demanded. It faces a more elastic demand curve due to product differentiation, allowing some degree of pricing power. Each firm faces its own demand curve, which can be shifted through successful product differentiation or advertising.

Marginal Revenue (MR) is the additional revenue a firm earns by selling one more unit of its product. In monopolistic competition, the MR curve lies below the demand curve to sell more units. The firm must lower the price, which applies to all units sold. As a result, the revenue gained from selling additional units diminishes.

Marginal Cost (MC) represents the additional cost of producing one more output unit. The curve initially decreases and then increases, forming a U-shape due to the law of diminishing returns. As production increases, the cost of producing each additional unit rises.

In summary, under monopolistic competition, firms' ability to set prices and earn profits is influenced by the interaction of MR, MC, and the demand curve, all of which are shaped by the degree of product differentiation and market competition. This framework helps explain why firms in these markets engage in non-price competition and why they may operate with excess capacity in the long run.

In monopolistic competition, the demand curve given by the average revenue curve slopes downward. This implies that a firm can sell more units at a lower price. Here, the demand curve is relatively elastic due to the availability of close substitutes.

The marginal revenue curve also slopes downward and lies below the demand curve, decreasing at a faster rate. Consider a coffee shop that lowers prices to attract more customers. To sell more cups, the price of all cups must be reduced, not just the additional ones. While it gains revenue from selling the extra cup at the new lower price, it loses revenue on previous cups that could have been sold at the old, higher price. As a result, marginal revenue is always less than the price per cup, which is the average revenue. This causes the MR curve to lie below the AR curve.

On the other hand, the marginal cost curve initially decreases and then increases, forming a U-shape.

Together, these curves show how the firm makes decisions about pricing and production.