Pricing and Output Decisions:

Monopolistic Competition

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 Monopolistic Competition

Imperfect Competition

Characteristics

• Some market power but not absolute market power.

• Have the ability to set prices within certain constraints
• Mutual Interdependence
• Interaction among competitors when making decisions
• Comparison of Market Structures

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 Comparison of Market Structures

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 Monopolistic Competition

• Monopolistic Competition
(market power based on product differentiation)

• Large number of relatively small firms acting independently

• Differentiated product
• Market entry and exit relatively easy
• Non-price competition very important
• Downward sloping demand for product

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Monopolistic Competition

Profit Maximization ?
Use the MR=MC rule
P* ?
Q* ?

What will happen in the long run ?

Why?

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Monopolistic Competition
In the long run, above normal
profits invite entry.

Why?
Entry of additional firms causes
the demand curve for each
existing firm to shift to the left.

In the long run, monopolistically

competitive firms earn normal
profits.

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Monopolistic Competition
Describe the firm’s
profitability.
Economic Loss
What will happen in the
long run?
Firms will exit
Demand curve shift to the
right.

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 Long-run Monopolistic Competition Equilibrium

Monopolistic Competition

Free entry and exit effect

existing firm’s demand until
zero profits result.

This is long-run
monopolistic firm’s
equilibrium.

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 Monopolistic Competition

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 Profit-Maximization

Like a competitive firm, a monopolistic competitive

firm maximizes profit by producing the quantity
where MR = MC.

Once the monopolistic Competitive firm identifies

this quantity Q, it sets the highest price
consumers are willing to pay for that quantity.

It finds this price P from the D curve.

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 Monopolistic Competition : LR and SR
Short run:
Under monopolistic competition, firm behavior is very similar to
monopoly.
Long run: In monopolistic competition, entry and exit drive economic
profit to zero.
If profits in the short run:
New firms enter market, taking some demand away from existing
firms, prices and profits fall.
If losses in the short run:
Some firms exit the market, remaining firms enjoy higher demand
and prices.

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 References

Book:
Managerial Economics, Seventh Edition, Paul G. Keat

Chapter 9

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