CHAPTER 7Dynamics of
markets:Imperfect markets
MONOPOLISTIC
COMPETITION
IntroductionMonopolistic competition: market structure in which many sellers each produce similar, but slightly differentiated, products.
Much of the world’s output of services produced monopolistically competitive industries.
Examples…• Doctors• Restaurants• Dentists• Hotels and guesthouses• Hairdressers
• Lawyers• Corner shops• Accountants• Architects• Fast-food outlets
Characteristics of
monopolistic competition
1. Differentiated products• Product differentiation: the act of making a product that is slightly
different to the product of a competing firm.• Differs from perfect comp. in that many firms produce a
differentiated product. • Goods/services good substitutes, but differentiated.• Homogeneous or heterogeneous – consumers decide!
Techniques of product differentiation include
What’s the point of Product Differentiation?
The greater the real or perceived differentiation, the less price
elastic demand becomes.
2. Many sellers• Many sellers, BUT each has monopoly of its own differentiated
product & therefore some market power. • Eg – dentist that’s great with children
•Ability to increase price (use market power) limited due to substitutes.• Therefore, face a downward-sloping demand curve. •Demand more price elastic (flatter) than for
oligopolistic firms, due to increased consumer choice.
2. Many sellers (cont.)
3. Freedom of entry and exit• Implies ability to make economic profits (or losses)
only in short run. • In the long run only normal profits possible.
4. Incomplete knowledge about the market• Firms do not have perfect information about consumers’ or other
firms behaviour.
Difference Between Perfect and Monopolistic Competition
Perfect Competition
Homogenous productsHorizontal demand curve
Monopolistic Competition
Differentiated productsDownward facing demand
curve
The SHORT RUN equilibrium of monopolistically competitive firmDownward-sloping D = ARPED > monopoly
Economic profit per unit = AR - AC at Q1. MR intersects halfway between the price axis & demand
(AR)Profit is maximised where MR = MC
P1; Q1
The LONG RUN equilibrium of the firm under monopolistic competitionDemand falls (substitutes). D & MR shift left. No further entry into the industry. D becomes more price elastic
(more close substitutes) Economic profits eliminated MR = MC & AR = AC.
AR curve tangent to AC curve.
SHORT RUN EQUILIBRIUM LONG RUN EQUILIBRIUM
Good example with figures on page 181 of text book…
Summary• Each firm has a monopoly of its differentiated product. • BUT… face strong competition from many other firms in the
industry. • All firms try to increase demand make economic profits.• BUT… free entry ensures that normal profits made in long
run.