Monopolistic Competition Very similar to monopoly, except along with the usual assumptions (profit maximisers with market

power), the market is assumed to have: 1. Very low/no barriers to entry 2. Very low/no barriers to exit (significant absence of sunk costs) This is because, monopolistic competition is considered to be contestable. This is the theory behind the behaviour of a monopolistic competitive firm. Initially, we have a firm that charges profit maximising price and earning SNP, as the market is contestable, new entrants are signalled to the market and encouraged to enter due to the SNP and compete for market share. This takes away market share away from the incumbent firm (which is illustrated by the inward shift of the demand curve), forcing the price to go down where the firm would only make normal profits. This helps to explain why the incumbent firm might not even charge a profit maximising price in the first place since it would realise/anticipate the threat of entry that this price would signal. This means that firms in this market have monopoly power, however rather than earning SNP in the long run, they only earn NP.

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