In the short run, a monopolistically competitive firm will produce at the quantity where marginal cost equals marginal revenue to maximize profits. This occurs at a price above average cost, resulting in abnormal profits. In the long run, entry of new firms shifts individual demand curves down and costs curves up, eliminating abnormal profits so firms only earn normal profits where price equals average cost, establishing equilibrium.

1. Equilibrium in short and long run

2. Equilibrium in short run
• Like monopolies, the suppliers in monopolistic competitive
markets are price makers and will behave similarly in the
short-run. Also like a monopoly, a monopolistic competitive
firm will maximize its profits by producing goods to the point
where its marginal revenues equals its marginal costs.
• The profit maximizing price of the good will be determined
based on where the profit-maximizing quantity amount falls
on the average revenue curve. The profit the firm makes is the
the amount of the good produced multiplied by the difference
between the price minus the average cost of producing the
good. .

3. Equilibrium in short run
• The firm will produce quantity Qs at
price Ps. The firm produces where
marginal cost (MC) and marginal revenue
(MR) curves meet
• This means that the shaded area
between Ps, ACs and the AR curve is the
abnormal profit the firm makes. AR is
equivalent to the demand curve and is
the average revenue the firm makes per
item sold. Producing at this point ensures
the highest amount of profit. Thus,
equilibrium is created in the short run.

4. Equilibrium in long run
• In the long run, there is entry and exit of firms in a monopolistic
competitive industry and the adjustment process will ultimately
lead to the existence of only normal profits. This is a realistic
assumption for in the long-run no firm can earn either super-
normal profits or incur losses because each produces a similar
product.
• If firms in the monopolistic competitive industry are earning super-
normal profits, new firms will be attracted into the group. With the
entry of new firms, the existing market is divided among more
sellers so that each firm will sell lesser quantities of the product
than before. As a result, the demand curves faced by individual
firms shift down to the left. At the same time, the entry of new
firms will increase the demand and hence the price of factor-
services which will shift the cost curves of individual firms upward.

5. Equilibrium in the long run
• In this diagram, the firm produces
where the LRMC, and the marginal
revenue curve meets. Because the
LRAC curve is above the AR curve,
there is no abnormal profit, as the
average cost of the good equals the
average revenue of the good. Thus, in
the long run, equilibrium is acquired.