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Monopolistic competition slide 1

MONOPOLISTIC COMPETITION

A market form in which there is:

1) Product differentiation.

2) Many firms.

3) Easy entry and exit.

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The importance of monopolistic competition is that itseems to explain aspects of many important real

world markets.

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SOME EXAMPLES

Shoe stores

Pizza parlors

Fast food, in generalLocal moving companies

Hand calculators

PC compatible clones

Others you can think of ...

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The demand curve facing a monopolisticallycompetitive firm looks very much like thatfacing a monopoly, but it is very elastic due tothe presence of many close substitutes.

$/Q

D

Q

Greasy Sams Hamburgers

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$/Q

D

Q

Because the demand

curve is negativelysloped marginal

revenue must be less

than average

revenue.

MRGreasy Sams Hamburgers

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The short-run analysis of the monopolisticallycompetitive firm proceeds exactly as for

monopoly, because in the short-run entry and exitare not possible.

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$/Q

D

Q

MR

MCAC

With the the cost curves shown below,

the firm can maximize profits by

choosing output where MC = MR.

p*

Q*


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$/Q

D

Q

MR

MCAC

Profits are shown by theshaded area.

p*

Q*


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$/Q

D

Q

MR

MCAC

p*

Q*


What happens in the long-run, as

firms can enter or leave?

The following hidden slide

shows the process.

Hidden slide

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$/Q

D

Q

MR

MCAC


As new firms enter, the demandcurve for this firm shifts down.

p*

Q*

If existing firms can earn profits,

there is an incentive for new firms to

enter.The process of entry will continueuntil the incentive to enter goes

away. That is, profit must be zero.

So in the long-run the equilibrium of

the firm in monopolistic competition

will look like this.

p'

Q'

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Do monopolistically competitive firms operate insocietys interest? Do they produce outputs and

sell at prices which maximize surplus? Are thefirms economically efficient?

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Generally no, because price will be

greater than marginal cost. But

because the demand curve is likely to

be very elastic, the difference between

P and MC may not be very great.

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SUMMARY OF MONOPOLISTIC

COMPETITION

1) In the short-run firms choose price andoutput by setting MC = MR.

2) In the long-run entry of new firms assuresthat profit will be zero.

3) Some economic inefficiency exists becausein equilibrium price is higher than marginal

cost.

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