Monopolistic Competition

1
Introduction
 This market structure is a combination of
elements from perfect competition and
monopoly.

 When there is a large no of firms producing

differentiated products, each one has a
monopoly of its own product but is subject to
the competition of close substitutes.

 Since each one is a monopolist and yet has

competitors, we have a market situation which
is termed as ‘monopolistic competition’.

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 Types of Product Differentiation
 Product differentiation helps companies or
consumers differentiate the product of one
producer from that of another in the industry.

 Product differentiation can be :

 Real
 Fancied

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Characteristics of Monopolistically
Competitive Markets
 Large number of firms

 Product differentiation

 Non price competition

 Freedom of entry and exit

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 Monopolistic Competitors in the Short
Run...

(a) Firm Makes a Profit

Price
MC
ATC

Price
Average
total cost
Profit Demand
MR

0 Profit-
Quantity
maximizing quantity
Monopolistic Competitors in the Short
Run...
(b) Firm Makes Losses
ATC
MC
Price
Losses

Average
total cost
Price

Demand
MR

0 Loss- Quantity
minimizing
quantity
 Monopolistic Competition in the Short
Run

 Short-run economic profits encourage new firms to

enter the market. This:

 Increases the number of products offered.

 Reduces demand faced by firms already in the

market.

 Existing firms’ demand curves shift to the left.

 Demand for the existing firms’ products fall, and their

profits decline.
 Monopolistic Competition in the Short
Run
 Short-run economic losses encourage firms to
exit the market. This:

 Decreases the number of products offered.

 Increases demand faced by the remaining firms.

 Shifts the remaining firms’ demand curves to the

right.

 Increases the remaining firms’ profits.

 The Long-Run Equilibrium

Firms will enter and exit

until the firms are making
exactly zero economic
profits.
 A Monopolistic Competitor
in the Long Run...

Price
MC
ATC

P=ATC

Demand
MR
0 Profit-maximizing Quantity
quantity
 Monopolistic versus Perfect Competition...

(a) Monopolistically Competitive Firm (b) Perfectly Competitive Firm

Price Price
MC MC
Markup ATC ATC

P
P = MC P = MR
Marginal (demand
cost curve)

MR Demand

Quantity Efficient Quantity Quantity produced = Quantity

produced scale Efficient scale
Excess capacity