IMPERFECT COMPETITION

• Imperfect competition refers to those

market structures that fall between perfect
competition and pure monopoly.
• Imperfect competition includes industries
in which firms have competitors but do
not face so much competition that they
are price takers.
 IMPERFECT COMPETITION
• Types of Imperfectly Competitive Markets
– Oligopoly
• Only a few sellers, each offering a similar or
identical product to the others.
– Monopolistic Competition
• Many firms selling products that are similar but not
identical.
The Four Types of Market Structure

Number of Firms?

Many
firms

Type of Products?

One Few Differentiated Identical

firm firms products products

Monopolistic Perfect
Monopoly Oligopoly Competition Competition

• Tap water • Tennis balls • Novels • Wheat

• Cable TV • Crude oil • Movies • Milk

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 Monopolistic Competition
Chamberlin’s model:

There is a clearly defined “industrial group”

which consists of a large number of
producers of goods that are close but
imperfect substitutes of each other

PRODUCT DIFFERENTIATION
 Monopolistic Competition
• Many small producers and free entry and
exit in the long run – like perfect
competition
• Firms do not believe that they can
influence market conditions nor do they
react to each others’ actions
 Monopolistic Competition
• However, firms produce goods that are
imperfect substitutes for each other.
• Hence, each firm has a market niche,
where it can act as a monopoly.
• The demand curve facing each firm is
downward sloping – like monopoly
• Chamberlin’s model stands midway
between models of perfect competition
and monopoly
Equilibrium in the Short Run and the Long Run

A MONOPOLISTICALLY COMPETITIVE FIRM IN THE SHORT AND LONG RUN

Because the firm is the
only producer of its
brand, it faces a
downward-sloping
demand curve.
Price exceeds
marginal cost and the
firm has monopoly
power.
In the short run, price
also exceeds average
cost, and the firm
earns profits shown by
the yellow-shaded
rectangle.
Equilibrium in the Short Run and the Long Run

A MONOPOLISTICALLY COMPETITIVE FIRM IN THE SHORT AND LONG RUN

In the long run, these
profits attract new
firms with competing
brands. The firm’s
market share falls, and
its demand curve shifts
downward.
In long-run equilibrium,
price equals average
cost, so the firm earns
zero profit even though
it has monopoly power.
 Monopolistic Competition
The long run monopolistic competition
equilibrium:
• 1. Each firm, acting as a monopoly, must
be maximizing profit by equating MR with
MC.
• 2. Free entry and exit leads to a situation
where each firm earns zero profit.
Monopolistic Competition and Economic Efficiency

COMPARISON OF MONOPOLISTICALLY COMPETITIVE EQUILIBRIUM AND

PERFECTLY COMPETITIVE EQUILIBRIUM
Under perfect
competition, price
equals marginal cost.
The demand curve
facing the firm is
horizontal, so the
zero-profit point
occurs at the point of
minimum average
cost.
COMPARISON OF MONOPOLISTICALLY COMPETITIVE EQUILIBRIUM AND
PERFECTLY COMPETITIVE EQUILIBRIUM
Under monopolistic
competition, price
exceeds marginal cost.
Thus there is a
deadweight loss, as
shown by the yellow-
shaded area.
The demand curve is
downward-sloping, so
the zero profit point is
to the left of the point
of minimum average In both types of markets, entry occurs until profits are driven to zero.
cost.
Is monopolistic competition then a socially undesirable market structure
that should be regulated? The answer—for two reasons—is probably
no:
1. In most monopolistically competitive markets, monopoly power is
small.
Usually enough firms compete, with brands that are sufficiently
substitutable, so that no single firm has much monopoly power. Any
resulting deadweight loss will therefore be small. And because firms’
demand curves will be fairly elastic, average cost will be close to the
minimum.
2. Any inefficiency must be balanced against an important benefit from
monopolistic competition: product diversity.
Most consumers value the ability to choose among a wide variety of
competing products and brands that differ in various ways. The gains
from product diversity can be large and may easily outweigh the
inefficiency costs resulting from downward-sloping demand curves.