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.