Monopolistic C M li i Competition ii

Monopolistic M li ti Competition C ii

Characteristics 1) Many firms 2) F Free entry and exit d i 3) P d t are differentiated, but are Products diff ti t d b t generally close substitutes for each other

Monopolistic Competition
The amount of market power d h f k depends on the d h degree of differentiation. Differentiation occurs via: physical differences, location, i l ti image and service. d i Examples include

P

A Monopolistically Competitive Firm in the Short and Long Run

PSRbca=supernormal profit Short Run
P

Since PLR=AC, supernormal profit=zero profit zero Long Run MC AC

MC AC

PSR a c

b PLR DSR DLR MRSR QSR

Quantity

Beer Cigarettes Ci Toothpaste

3

MRLR QLR
Quantity

Observations (short run)

Observations (long run)

Supernormal profits will attract new firms to S l fit ill tt t fi t the industry since there are no barriers to entry The original firms demand will decrease to DLR Firm Fi s output and price will f ll t t d i ill fall Industry output will rise Zero economic profit since P = AC P > MC, implies some market power

Downward sloping demand due to differentiated product Demand is relatively elastic good substitutes MR < P Profits are maximized when MR = MC This firm is making supernormal profit

Comparison of Monopolistically Competitive Equilibrium and Perfectly Competitive Equilibrium

Perfect Competition
P P

Monopolistic C M li ti Competition titi

AC

Monopolistic Competition Monopolistic Competition and Efficiency While there are no economic profits in the long run, the firm is still not producing at minimum AC, excess capacity exists. There is AC exists productive inefficiency. Note also that P > MC. The equilibrium is not characterised by y allocative efficiency There is a deadweight loss associated with monopolistic competition These efficiency costs may however be offset by the greater choice y y y g (due to product differentiation) offered to the consumer under monopolistic competition

MC

AC

MC

PMCom PC D = MR DLR MRLR QC

Quantity

QMCom

Quantity