Monopolistic Competition

by Electra Radioti
Monopolistic Competition

Monopolistic competition is a market structure where many firms sell products that are similar but not identical. Unlike in perfect competition, firms have some degree of market power, allowing them to influence prices. However, because products are differentiated, the competition among firms is not purely based on price. Key characteristics of monopolistic competition include:

  1. Many Sellers: There are many firms in the market, each with a small market share.
  2. Product Differentiation: Each firm offers a product that is slightly different from its competitors. This differentiation can be based on quality, features, branding, or customer service.
  3. Free Entry and Exit: Firms can enter and exit the market with relative ease, which ensures that firms only make normal profits in the long run.
  4. Some Degree of Market Power: Due to product differentiation, firms have some control over their pricing but are still constrained by the availability of close substitutes.
  5. Non-Price Competition: Firms compete on factors other than price, such as advertising, product quality, and customer service.

Examples of Monopolistic Competition:

  • Restaurants: Each restaurant offers a unique menu, dining experience, and service.
  • Clothing Brands: Different brands offer unique styles, quality, and brand image.
  • Consumer Electronics: Various companies offer different features, designs, and brand prestige.

Characteristics of Monopolistic Competition:

  1. Downward Sloping Demand Curve: Each firm faces a downward sloping demand curve because its product is differentiated.
  2. Excess Capacity: Firms often produce below their capacity, leading to inefficiencies.
  3. Advertising and Marketing: Significant emphasis on advertising to differentiate products and attract customers.
  4. Short-Run and Long-Run Equilibrium: In the short run, firms can make supernormal profits or losses. However, in the long run, the entry and exit of firms ensure that only normal profits are made.

Short-Run Equilibrium:

  • In the short run, firms can earn supernormal profits if their average total cost (ATC) is below the price level at the quantity produced.
  • Firms can also incur losses if the ATC is above the price level.

Long-Run Equilibrium:

  • In the long run, the entry of new firms (attracted by short-run profits) and the exit of existing firms (due to short-run losses) lead to a situation where firms only earn normal profits.
  • The demand curve becomes tangent to the average total cost curve, indicating zero economic profit.

Imagine a typical firm in monopolistic competition with a downward sloping demand curve (D) and a corresponding marginal revenue curve (MR). The firm’s marginal cost curve (MC) intersects the MR curve at the profit-maximizing quantity. In the short run, the price is set above the average total cost, leading to supernormal profits. In the long run, the entry of new firms shifts the demand curve leftward until it is tangent to the ATC curve, resulting in normal profits.

Monopolistic Competition

Short-run equilibrium

Monopolistic Competition

Long-run equilibrium

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