Monopolistic Competition

• The characteristics of monopolistic competition are:

  • Many buyers and sellers
  • Goods and services are slightly differentiated
  • Low barriers to entry and exit
  • Firms compete strongly on non-price factors
  • Firms are profit maximisers (MC = MR) at all times
• In the short run, a profit maximising monopolistically competitive firm will produce where MC = MR, at this point, AR > AC meaning supernormal profits are being made
• In the long run, supernormal profits act as an incentive for new firms to enter the market and since there's low barriers to entry, a lot of new firms join meaning the demand curve shifts to the left which repeats until AR is tangential to AC and normal profit is being made
• Monopolistic competition long run performance:

  • They produce outcomes that are allocatively inefficient
  • They are productively inefficient
  • They are not dynamically efficient either
• Evaluation for monopolistic competition:

  • The allocative inefficiency arises from consumer demand for differentiated goods, consumers are willing to pay slightly higher prices than marginal cost for variety. This is in contrast to perfect competition that has static efficiency but product homogeneity which isn't preferred. The price exploitation is also very slight and much less than in a monopoly so this means that allocative inefficiency is somewhat purely theoretical since consumers gain greater utility from monopolistic competition

  
  

  (Card 1)
• Evaluation for monopolistic competition:

  • The productive inefficiency also arises from consumer demand for differentiated goods, the same point applies that the loss of efficiency isn't as significant as in a monopoly
  • The idea of always being dynamically inefficient may not hold in reality as some firms may be forced to reinvest short run supernormal profits or long run normal profits to stay ahead of rivals, this also gives them some monopoly power to use
  • It can be argued that monopolistic competition may be the best for maximising social welfare

  
  

  • (Card 2)
• Characteristics of monopolies, perfect competition and monopolistic competition: