a) Explain the difference between short-run and long-run equilibrium in monopolistic competition.
Monopolistic Competition is a market structure featuring few large and many small firms, fairly low entry barriers similar goods and relatively high competition. Over the short-run, firms can usually gain some abnormal profit, but over the long run, other firms entering the market due to the low entry barriers will compete and make the price lower.
Short run is a time period in which at least one factor of production is fixed; long run is when all factors of production are variable.
The firm will produce quantity Qs at price Ps. The firm produces where marginal cost (MC) and marginal revenue (MR) curves meet, because MC is the cost of producing an one more of the good and MR is the revenue of selling one more good and their meeting point is the most efficient production. This means that the shaded area between Ps, ACs (average cost of producing one good at this quantity) and the AR curve (average revenue 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.
In the long run, there are no abnormal profits because of the features of Monopolistic competition. There are a few large firms, but many small firms that will compete for profit and thus drive the price down. Also, low entry barriers mean new firms will enter the market and further add competition. Finally, the goods are similar enough to ensure that competition will always remain high.
Long Run Equilibrium
In this diagram, the firm produces where the LRMC, or long run marginal cost curve, and the marginal revenue curve meets. The LRMC describes the cost of producing one more of the good when no factors of production are fixed over the long run. That point is, in the long run, equivalent to the LRAC, or long run average cost curve, which shows them average cost of producing one good at this quantity over the long run. 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.
Essentially, the difference between short and long run equilibrium is that in short run equilibrium, the firm can gain abnormal profits. Over the long run, that is impossible.