Monopolistic competition

• What type of profit do perfectly competitive markets make in the long run?

  normal profit
• what are the 4 conditions of perfect competition?

  Many small buyers and sellers

  No barriers to entry or exit

  Homogeneous products

  Perfect information
• What are the 3 assumptions of monopolistic competition?

  many buyers and sellers

  low barriers to entry - no economies of scale, few patents and low sunk costs

  differentiated goods - similar but slightly different
• In the short run where does a monopolistic firm maximise their profit?

  Where MC=MR

  
• What happens when a monopolistic firm makes supernormal profits in the short run?

  Other firms will be incentivised to join the market, and they can join easily because of low barriers to entry.
• What happens to the incumbent firm when more new entrants join the market?

  The incumbent firm will lose customers, leading to AR and MR decreasing
• What type of profit do monopolistically competitive firms make in the long run?

  normal profit, supernormal profits have been eroded

  
• summarise short run and long run in a monopolistically competitive firm?

  In the short run, if a monopolistically competitive firm is making supernormal profit, it will incentivise new firms to enter the market. There are low barriers to entry, so new firms will enter the market, stealing customers from existing (or incumbent) firms.This will decrease their demand (or AR), shifting AR and MR down, until AR just touches the firm’s AC curve - so only normal profit will be left and all the supernormal profit is gone. Potential suppliers outside the market will no longer enter the market because they can no longer make supernormal profit, so we have reached the long run equilibrium.
• Why aren't monopolistic markets productively efficient in the long run?

  firms operate on downward sloping demand curve - they don't produce where ATC is minimised unlike in perfect competition

  To increase normal profit -> product differentiation is prioritised over cost minimisation

  This is shown in the long run where the equilibrium output is left of the ATC minimum showing higher per unit costs
• Why aren't monopolistic firms allocatively efficient in the long run?

  Downward sloping demand curve shows firms have price setting power: Price is set to be more than MC to maximise profits

  Deadweight loss: output is lower than the socially optimal level so there is a welfare loss.

  Consumer trade off: Consumers benefit from variety from product differentiation, however high prices have to be paid.
• What form of competition is product differentiation and variety?

  non price compeitition