Monopolistic competition

• Monopolistic competition


  A very interesting real world market structure that is a competitive market but with some characteristics of monopoly
• Characteristics of monopolistic competition


  • Many buyers and sellers in the market
  • Firms sell slightly differentiated goods
  • Firms are price makers but only slightly due to good substitutes available
  • Firms have price elastic demand curves
  • Low barriers to entry and exit
  • Good information of market conditions
  • Firms engage in non-price competition (e.g. branding, advertising, quality)
• Profit maximization


  Firms produce where marginal cost (MC) is equal to marginal revenue (MR)
• Examples of monopolistically competitive markets

  • Clothing markets
  • Taxis
  • Fast food restaurants
  • Hairdressers and salons
  • Bars and nightclubs
• Firm behaviour in the short run

  1. Downward sloping revenue curves

  2. Profit maximization at MR=MC

  3. Firms make supernormal profits
• Firm behaviour in the long run

  1. New firms enter the market

  2. Demand for individual firms shifts left

  3. Demand keeps shifting left until AR=AC (normal profit)
• As new firms enter the market


  Demand for individual firms shifts left
• In the long run, firms in monopolistic competition make normal profit
• Efficiency in monopolistic competition

  • Allocated efficiency not achieved as price > marginal cost
  • Productive efficiency not achieved as not at minimum of AC curve
  • Dynamic efficiency uncertain as no guarantee of supernormal profits for reinvestment
• Compared to monopoly


  Monopolistic competition has lower price exploitation and less loss of consumer surplus
• Compared to perfect competition


  Consumers may prefer product differentiation even if it leads to some allocative inefficiency
• Compared to perfect competition


  Productive inefficiency may be due to meeting consumer demand for variety rather than exploiting economies of scale
• Compared to monopoly


  Dynamic efficiency may be more likely in monopolistic competition due to reinvestment as part of competition