In the short run, then, the monopolistically competitive firm faces limited competition. There are other firms that sell products that are good, but not perfect, substitutes for the firm's own product. In the words of British economist Joan Robinson, every firm has a monopoly of its own product. When the product is differentiated, that means the firm has some monopoly power -- maybe not much, if the competing products are close substitutes, but some monopoly power, and that means we must use the monopoly analysis, as if Figure 1 below.
We see that, as usual in monopoly analysis, the marginal revenue is less than the price. The firm will set its output so as to make marginal cost equal to marginal revenue, and charge the corresponding price on the demand curve, so that in this example, the monopoly sells 1000 units of output (per week, perhaps) for a price of $85 per unit.
But this is just a short run situation. We see that the price is greater than the average cost (which is $74 per unit, in this case) giving a profit of $11,000 per week. We remember too that this is economic profit -- net of all implicit as well as explicit costs -- so this profitable performance will attract new competition in the long run. What that means is that new firms will set up, and existing firms will change their products, so that there will be more, and closer, substitutes in the long run. That will shift the demand for this firm's profits downward, and perhaps cause the cost curves to shift upward as well, squeezing the profit margins.
