BY: LINDSEY REED AND CARLY BEIER

Monopolistic Competition

Characteristics of Monopolistic Competition

1. Relatively large number of sellers2. Differentiated products (promoted by heavy

advertising)3. Easy entry and exit from the industry

#1&#3 provide the competitive aspect and #2 provides the monopolistic aspect.

1. Relatively Large Number of Sellers

Small Market Shares- each firm has a comparatively small % of total market and has limited control over market price.

No Collusion- the large number of firms prevents collusion by a group of firms to restrict output and set prices.

Independent Action- there is no feeling of independence due to the amount of firms in an industry, but each firm can control their own pricing without considering the reaction of rival firms.

2. Differentiated Products

Monopolistic Competition is distinguished by product differentiation-can change a product’s physical characteristics, proclaim special qualities, services, locations, names, etc… Product Attributes- they can change the product’s design and add different

materials. Service- the appeal of the store, helpfulness of employees, the firm’s

reputation, and the credit it makes available. Location- being close to customers and on busy streets to gain business Brand Names/Packaging- use of the brand name, trademarks, packaging,

and celebrity connections. Price Control- has limited control over prices, because of product

differentiation. If customers prefer a certain brand, they will pay higher prices to get it. The control is limited, because there are numerous close substitutes.

Advertising- firms advertise how different their product is from everyone else Nonprice competition- make price less of a factor in consumer purchases and

emphasize the unique product.

3. Entry and Exit From the Industry

Entry is easy Because monopolistic Competitors are typically smaller

firms, both absolutely and relatively, economies of scale are few and low capital requirements.

Compared to pure competition, financial barriers may result from the need to develop and advertise a product that differs from the other products.

Firms will hold patents on their unique products to ensure other firms will not imitate them.

Exit is easy Nothing prevents an unprofitable Monopolistic

Competitor from leaving or shutting down

Demand Curve

Price elasticity of the demand curve depends on the number of rivals and the degree of product differentiation

The demand curve in a monopolistic competition is highly elastic (not perfect).

It is not perfect, because compared to pure monopoly, there are several close substitutes to the goods being sold in a Monopolistic Competition.

Compared to pure competition, it is not perfectly elastic, because in Monopolistic Competition there are few rivals and products are differentiated.

Short Run- Economic Profits

Firms enter and attract new rivals when products are making profits, because entry is easy.

Demand curve shifts to the left when firms enter and this reduces economic profit.

When entry of new firms has reduced demand to the extent that the curve is tangent to the ATC at the profit maximization output, the firm goes to equilibrium or “normal profit” in the long run.

Short Run- Economic Loss

Firms exit and the demand curve shifts to the right, sending it to equilibrium or to make a “normal profit” in the long run.

The firms are faced with fewer substitutes and blessed with an expended share of total demand.

Long Run Graph

Firms will enter a profitable monopolistic competitive industry and leave an unprofitable one.

The demand curve will shift as people enter and exit, but it will make its way back to “normal profit” or equilibrium.

Some firms may have sufficient monopoly power to realize modest economic profit even in the long run.

Efficiency of Monopolistic Competition

Neither productive or allocative efficiency occurs in the long run.

Economic efficiency is defined as P = MC = minimum ATC, and as you can see in the graph, the P3 is plotted above the minimum ATC and the MC, meaning it is not efficient economically (which is made up from productive and allocative efficiency.

Excess Capacity

Excess Capacity- plant and equipment that are underused because firms are producing less than minimum ATC output.

If each Monopolistic Competitor could produce at minimum ATC, fewer firms could produce at the same total output and could be sold at a lower price.

Product Variety

Product variety allows more profit, due to the product’s differentiation

Differentiation allows the offer of a wide range of types, brands, styles, and quality of a certain product.

Product improvement causes rivals to search for other advances in technology to make their product better; the cycle of products will continue to get better

Product differentiation creates a wider range of consumer choice and will lead to a higher productive effieciency