How do Monopolistic Competitors Choose Price and Quantity?

The monopolistically competitive firm decides on its profit-maximizing quantity and price in much the same way as a monopolist. A monopolistic competitor, like a monopolist, faces a downward-sloping demand curve, and so it will choose some combination of price and quantity along its perceived demand curve.

We can multiply the combinations of price and quantity at each point on the demand curve to calculate the total revenue that the firm would receive.

We calculate marginal revenue as the change in total revenue divided by the change in quantity.

We calculate marginal cost by dividing the change in total cost by the change in quantity, while we calculate average cost by dividing total cost by quantity.

Although the process by which a monopolistic competitor makes decisions about quantity and price is similar to the way in which a monopolist makes such decisions, two differences are worth remembering.

First, although both a monopolist and a monopolistic competitor face downward-sloping demand curves, the monopolist’s perceived demand curve is the market demand curve, while the perceived demand curve for a monopolistic competitor is based on the extent of its product differentiation and how many competitors it faces.

Second, a monopolist is surrounded by barriers to entry and need not fear entry, but a monopolistic competitor who earns profits must expect the entry of firms with similar, but differentiated, products.

Determine the Quantity and Price to Produce

The process by which a monopolistic competitor chooses its profit-maximizing quantity and price resembles closely how a monopoly makes these decisions process.

First, the firm selects the profit-maximizing quantity to produce. Then the firm decides what price to charge for that quantity.

Step 1. The monopolistic competitor determines its profit-maximizing level of output. So, determine the profit-maximizing quantity to produce by considering its marginal revenues and marginal costs. Two scenarios are possible:

• • • If the firm is producing at a quantity of output where marginal revenue exceeds marginal cost, then the firm should keep expanding production, because each marginal unit is adding to profit by bringing in more revenue than its cost. In this way, the firm will produce up to the quantity where MR = MC.
    • If the firm is producing at a quantity where marginal costs exceed marginal revenue, then each marginal unit is costing more than the revenue it brings in, and the firm will increase its profits by reducing the quantity of output until MR = MC.

Step 2. The monopolistic competitor decides what price to charge. When the firm has determined its profit- maximizing quantity of output, it can then look to its perceived demand curve to find out what it can charge for that quantity of output.

Once the firm has chosen price and quantity, it’s in a position to calculate total revenue, total cost, and profit. Profits are total revenues minus total costs, which is the shaded area above the average cost curve.