MONOPOLISTIC COMPETITION

1
MONOPOLISTIC COMPETITION

• A market form in which there is
• 1) Product differentiation.
• 2) Many firms.
• 3) Easy entry and exit.

2

• The importance of monopolistic competition is
  that it seems to explain aspects of many
  important real world markets.

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SOME EXAMPLES

• Shoe stores
• Pizza parlors
• Fast food, in general
• Local moving companies
• Hand calculators
• PC compatible clones
• Others you can think of ...

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• The demand curve facing a monopolistically
  competitive firm looks very much like that facing
  a monopoly, but it is very elastic due to the
  presence of many close substitutes.

/Q
D
Q
Greasy Sams Hamburgers
5
Because the demand curve is negatively sloped
marginal revenue must be less than average
revenue.
/Q
D
Q
Greasy Sams Hamburgers
MR
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• The short-run analysis of the monopolistically
  competitive firm proceeds exactly as for
  monopoly, because in the short-run entry and exit
  are not possible.

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With the the cost curves shown below, the firm
can maximize profits by choosing output where MC
MR.
/Q
AC
MC
p
D
Q
Q
MR
Greasy Sams Hamburgers
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Profits are shown by the shaded area.
/Q
AC
MC
p
D
Q
Q
MR
Greasy Sams Hamburgers
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What happens in the long-run, as firms can enter
or leave? The following hidden slide shows the
process.
/Q
AC
MC
p
D
Q
Q
Hidden slide
MR
Greasy Sams Hamburgers
10
As new firms enter, the demand curve for this
firm shifts down.
/Q
AC
MC
D
Q
MR
Greasy Sams Hamburgers
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• Do monopolistically competitive firms operate in
  societys interest? Do they produce outputs and
  sell at prices which maximize surplus? Are the
  firms 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 and
  output by setting MC MR.
• 2) In the long-run entry of new firms assures
  that profit will be zero.
• 3) Some economic inefficiency exists because in
  equilibrium price is higher than marginal cost.