monopolistic competition

• key characteristics of monopolistic competition

  low barriers to entry

  some market power

  large number of buyers and sellers acting independently

  firms which act as profit maximisers in the short run
• monopolistic competition

  much closer to perfect competition than monopoly

  highly competitive market structure where firms are producing a differentiated product
• monopolistic competition

  a market structure where a large number of small firms produce differentiated (non-homogenous) products and where there are low barriers to entry or exit
• product differentiated

  allows firms to charge a different price to reflect any unique qualities of their product/service

  they are 'price makers' and have a downward sloping demand curve - a lower price will bring greater demand

  PED is relatively elastic

  but with a large number of competitors producing relatively close substitutes, their market power is relatively weak
• what might firms use to compete with each other, other than price

  • innovations
  • customer service
  • after sales service
  • loyalty schemes
  • branding
  • packaging
  • promotions
  • marketing
• examples of monopolistic competition

  • coffee shops
  • hairdressers
  • nail salons
  • pizza delivery business
  • sandwich bars
  • corner grocery stores
  • private tutors
  • launderettes
• factors that affect the 'pricing power' of an individual firm in monopolistic competition

  1. number of competitors with similar products/services, more competitors, PED is elastic, competitively priced
  2. product differentiation, allows firms to charge different price to reflect any unique qualities of product/service
  3. low barriers to entry and exit, firm has to price competitively
• profit in monopolistic competition in the long run

  supernormal profits - more firms enter the market - demand curve for incumbent firms shifts in - process continues until AR=AC
• monopolistic competition

  in the LR, equilibrium in monopolistic competition, the representative firm in the market is making normal profits

  in reality, a stable equilibrium may not be reached since new products come and go, and some naturally do better than others, the market may be in a state of constant flux

  existing products within a market will typically go through a product life cycle that affects the volume and growth of sales

  length of the product life cycle varies from market to market, many businesses spend heavily on marketing/innovation to extend the life of profitable brands
• monopolistic competition - allocative efficiency

  firms in monopolistic competition do not operate where MC=AR in theory

  practice - it's about producing what consumers actually want to buy, can be achieved due to product differentiation
• monopolistic competition - dynamic efficiency

  in the long run, no supernormal profits and so no finance for R&D and innovation with products or processes

  practice - firms differentiate their products and continue to do so, so there must be some dynamic efficiency, there are other ways to finance e.g. borrowing, share issue etc
• monopolistic competition - productive efficiency

  in theory firms in monopolistic competition do not operate at lowest average cost

  practice - firms in monopolistic competition can face fierce competition so will be incentivised to keep their average costs as low as possible to keep prices low