Answer to Question #195003 in Microeconomics for addy

Question

For market failure unit (market power). In the long run graph for monopolistic competition, firms are no longer earning abnormal profit due to low barriers to entry as there are more similar goods on the market, lowering demand, causing them to earn normal profits, however, shouldn't that cause MR to be equal to AR (demand curve), similar to the normal profit in perfect competition? Why is MR less than AR here when it is earning normal profit?

Answer 1

Firms in the perfectly competitive market structure act as price-taking firms and they take the market price of the product as given. The firms in the perfectly competitive market structure face a perfectly elastic demand curve for their product and this perfectly elastic demand curve indicates that the firms can sell as much they want at the going market price and therefore for perfectly competitive firms the marginal revenue is equal to average revenue(demand curve) or in other words for perfectly competitive firms the marginal revenue curve and average revenue curve is identical.

Firms in the monopolistic market structure face a downward-sloping demand curve for their product and when a firm faces the downward sloping demand curve for its product then the marginal revenue of the firm becomes less than the average revenue of the firm because when a firm faces a downward-sloping demand curve for its product then it is required to reduce the market price of all the units of the product it wants to sell so that it can sell one more unit of the product in the market. 

Therefore,for firms in the monopolistic market structure marginal revenue is always less than average revenue even when they are earning normal profits because firms in this market structure face a downward-sloping demand curve for their product.