Let us make an in-depth study of determination of value under imperfect competition.
Under Imperfect Competition or Monopolistic Competition individual firm’s market is isolated to a certain degree from those of his rivals with a result that his sales are limited and depends upon:
(a) The price of the product,
(b) The nature of the product, and
(c) The advertisement outlay.
In this market each firm has got its own option to fix the price of his own product. A slight change in the price by one firm may pass off completely un- noticed. A large reduction in price will no doubt draw customers from rival firms but if a large number of customers are attracted from rival firms they may be compelled or they may retaliate by cutting their prices.
The nature of the product may affect the clientage and the number of customers. The important and major factor which affects the price and outlay is the amount of advertisement expenditure incurred by each firm. In this market situation the demand curve (AR) is a downwards sloping curve which indicates that in order to sell more of his product a producer will have to reduce the prices.
The determination of price and outlay is same as in case of Perfect Competition and monopoly situation. The firm attains equilibrium where the marginal cost is equal to marginal revenue but afterwards the marginal cost must be rising. In the Imperfect Competition market we normally find three types of firms which have been divided on the basis of their productive efficiency.
1. The most efficient firm:
Whose average cost is less than the average revenue at the point of equilibrium. Hence, it earns abnormal profits.
2. The efficient firm:
Whose average cost and average revenue are equal at the point of equilibrium. Hence it earns normal profits.
3. The inefficient firm:
Whose average cost is more than the average revenue and hence earns losses.
The diagram of all three firms is given below:
In the above diagram, the output is determined at point E where MC = MR and after that MC must be rising. OQ output is determined in all the three firms. Firm A earns abnormal profits as his AR is more than the Average Cost i.e., (OP > OT). PT is per unit profit. The shaded area is his total profits. Firm B is a normal firm where AR=AC hence no abnormal profit.
Firm C is an efficient firm whose Average Cost is more than the average revenue. The shaded area is the losses earned by the firm C. Thus in the short period the nature of profits differs in different firms but in the long period each firm will be earning only normal profits.