Monopolistic Competition

• Monopolistic competition

  A market structure that shares some characteristics with both perfect competition and monopoly. Barriers to entry are low and many firms compete by selling similar, but not identical, products.
• Characteristics of monopolistic competition

  1. Many firms

  2. SLIGHTLY Differentiated products

  3. Few barriers to entry & exit

  4. Price maker (downward-sloping demand curve)

  5. Profit maximiser

  6. Heavy expenditure on advertising & branding

  7. No dominant firm
• Productive efficiency under monopolistic competition

  This is to operate at the lowest point of average cost and is the point where the MC curve crosses the bottom of the AC curve. Saturation of the market may lead to businesses being unable to exploit fully economies of scale causing average cost to be higher – therefore not productively efficient​
• Allocative efficiency under monopolistic competition

  This is concerned with the optimal distribution of products. This occurs if the price is equal to marginal cost. Prices are above marginal cost – meaning that the equilibrium is not allocatively efficient​
• Advantages of monopolistic competition

  1. More realistic than perfect competition.

  2. Differentiation brings greater consumer choice (than monopoly)​

  3. Greater competition than monopoly (due to low barriers to entry)​

  4. Product service and quality - firms may aim to develop to gain greater economic profit (incentive for firms to innovate)​
• Disadvantages of monopolistic competition

  1. X-inefficient: they can be wasteful due to spending on advertising, packaging & branding

  2. Productively inefficient: they do not produce enough output to reduce LRAC and experience economies of scale

  3. Allocatively inefficient: They do not produce at an output level where P=MC​

  4. A higher price may be charged than under perfect competition​
• Diagram to illustrate equilibrium price and output for a firm in short run monopolistic competition

  A) P

  B) Supernormal profit

  C) MC

  D) AC

  E) D = AR

  F) MR

  G) Q

  H) Quantity

  I) Price

  
• Diagram to illustrate equilibrium price and output for a firm in long run monopolistic competition

  A) MC

  B) AC

  C) P

  D) Q

  E) MR

  F) D = AR

  G) Price

  H) Quantity

  
• If the existing firms are making a profit, the new firms will enter the market. Consequently, the demand curve of the existing firms shifts leftwards. If the existing firms are incurring a loss, then some firms will exit the market.