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SHORT-RUN PRODUCTION: An analysis of the production decision made by a firm in the short run, with the ultimate goal of explaining the law of supply and the upward-sloping supply curve. The central feature of this short-run analysis is the law of diminishing marginal returns, which results in the short run when larger amounts of a variable input, like labor, are added to a fixed input, like capital. This analysis of short-run production is but the first step in a brisk walk toward a better understanding of supply. Further steps include the cost of short-run production, especially marginal cost, and the market structure in which a firm operates, such as perfect competition or monopoly.
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                           MONOPOLISTIC COMPETITION, SHORT-RUN SUPPLY CURVE: Market control means that monopolistic competition does not necessarily have a supply relation between the quantity of output produced and the price. In contrast, the short-run supply curve of a perfectly competitive is that portion of its marginal cost curve that lies above the minimum of the average variable cost curve. Because monopolistic competition does not set price equal to marginal revenue, it does NOT equate marginal cost and price. As such, a monopolistically competitive firm does not necessarily supply larger quantities at higher prices or smaller quantities at lower prices. A monopolistically competitive firm maximizes profit by producing the quantity of output that equates marginal revenue and marginal cost. In that price (and average revenue) is greater than marginal revenue in monopolistic competition, price is also greater than marginal cost. In other words, a monopolistically competitive firm does not produce output by moving along its marginal cost curve. The marginal cost curve is thus not the supply curve for a monopolistically competitive firm.As a price maker with some degree of market control, a monopolistically competitive firm reacts to demand conditions, especially the price elasticity of demand, when setting the price and corresponding quantity produced. While a monopolistically competitive firm, especially one with limited market control, is likely to sell a larger quantity for at a higher price, it is also conceivable that it might offer a smaller quantity at a higher price or a larger quantity at a lower price. Working DemandWhy is it that a monopolistically competitive firm might not have a direct relation between price and quantity supplied?The key is the price elasticity of demand. Market control allows a firm to "work the demand curve." If buyers are relatively responsive to price (more elastic demand), then the firm is likely to charge a lower price. If buyers are relatively unresponsive to price (less elastic demand), then the firm is likely to charge a higher price. The monopolistically competitive firm takes advantage of buyers elasticity when setting the price and quantity that maximizes profit. A perfectly competitive firm, in contrast cannot "work the demand curve" in this way. It can only respond to price, which it sets equal to marginal cost, to determine the profit-maximizing production level. This lack of market control is what establishes the marginal cost curve as the supply curve. Maybe a Supply Curve, Maybe NotThis analysis is not meant to imply that monopolistically competitive firm DOES NOT produce a larger quantity in response to a higher price. It indicates that it MIGHT NOT produce a larger quantity in response to higher price. However, the phrase "MIGHT NOT" is extremely important to the law of supply. Economic science pursues universal laws and economic principles that ALWAYS hold. In particular, the key obstacle to the positive price-quantity supply relation is market control and the negatively-sloped demand curve facing the monopolistically competitive firm. As a matter of fact, any firm with market control, which includes all market structures EXCEPT perfect competition, has the same qualification about supply. And because perfect competition does not exist in the real world, all real world market structures have questionable supply curve relationships. This is perhaps most important because implementing policies that are based on economic laws that may or may not hold can be troublesome. Given the realistic possibility that the law of supply does not hold, the application of market-based policies can prove difficult, especially if the policies presume that firms react to a higher price by increasing the quantity supply.
Recommended Citation:MONOPOLISTIC COMPETITION, SHORT-RUN SUPPLY CURVE, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2023. [Accessed: October 3, 2023].
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