3.4.3 Monopolistic competition

• Monopolistic competition:

  A market structure in which:

  -Large number of small firms

  -Low barriers to entry and exit

  -Firms produce similar but differentiated products

  Monopolistic competition is DIFFERENT to monopoly.
• What shape is a firm's demand curve in monopolistic competition?

  The demand curve is downward sloping as the firm is a price maker. Because firms sell a differentiated product, they can increase prices and still hold onto some of their customers.
• What is the short run equilibrium of firms in monopolistic competition?

  Firms aim to maximise profits and therefore will produce where MC=MR.

  Firms can either be making SNP or losses.

  Firms will be neither allocatively nor productively efficient.
• What happens to firms in monopolistic competition when we enter the long run?

  If firms are making SR SNP -> attract new entrants (easy to join because of low barriers to entry) -> reduce demand for existing firms -> erode SNP until only normal profit is made.

  If firms are making SR losses -> incentive for firms to leave the industry -> increase demand for existing firms -> reduce losses until normal profit is made.
• What is the long run equilibrium in monopolistic competition?

  Firms will make normal profits.

  Firms will be neither allocatively nor productively efficient.