MONOPOLISTIC

COMPETITION
 MARKET STRUCTURE

• Perfect competition, with an infinite number of firms, and

monopoly, with a single firm, are polar opposites
• Monopolistic competition and oligopoly lie between these two
extremes.
• Monopolistic competition is a market structure in which there
are many firms selling differentiated products
• There is no incentive for firms to cooperate in ways that reduce
competition
 CHARACTERISTICS OF MONOPOLISTIC
COMPETITION

1. Many sellers each satisfying a small but not microscopic share

of market

2. Product differentiation where the goods that are sold aren’t

homogenous

3. Ease of entry of new firms in the long run because there are
no significant barriers to entry
Firms compete by selling differentiated products that are highly
substitutable for one another but not perfect substitutes. The cross-
price elasticities of demand are large but not infinite.

16-3
 FEATURES

• A blend of competition and monopoly

• Competitive element: many sellers; firms can enter the
industry quite freely in long run
• Difference: sells differentiated products
• Monopoly element: due to differentiated product, each firm
enjoys some market power
• Difference: Market power is limited by existence of close
substitutes
• entry is rather easy
 DIFFERENTIATED PRODUCT

• Similar, but not identical

• Restaurants, toothpaste, detergents etc.
• Differentiation can be real (breakfast cereals)
• Differentiation can be non-real (aspirin)
• Rivalry among firms take place in forms of:
• Product quality
• Services
• Location rather than PRICE
 EXAMPLES OF PRODUCT
DIFFERENTIATION

• Sustainable - A ground breaking energy efficient model of car is sold out for
22 months after its launch.
• Right place - A luxury hotel is the only hotel located on a popular beach on a
South Pacific island.
• Experience - A chain of coffee shops provides a unique experience and has
friendly staff.
• Cute - A Japanese candy product stands out for its cute packaging and mascot.
• Reputation - A private bank stands out for its reputation for investment
results.
 MONOPOLISTIC COMPETITOR

• Chamberlin called the sellers of differentiated products as

‘product group’

• We cannot derive ‘industry’ supply and demand curves as we

do not have a single price, but a cluster of prices

• By demand facing the firm, we mean the market share of the

firm
OUTPUT, PRICE, AND PROFIT OF A
MONOPOLISTIC COMPETITOR
Like a monopoly
• The monopolistic competitive firm has some monopoly
power so the firm faces a downward sloping demand
curve
• Marginal revenue is below price
• At profit maximizing output, marginal cost will be less
than price

Like a perfect competitor,

• zero economic profits exist in the long run

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SHORT RUN EQUILIBRIUM
SHORT RUN EQUILIBRIUM
WITH NO PROFIT
 SHORT RUN EQUILIBRIUM
WITH LOSS

The firm will shut down if P falls short of AVC

 LONG RUN EQUILIBRIUM

D1
D2 LMC LAC

P*

D1
D2
MR
q*

MR = LMC as well as P = LAC to ensure there is no profit no loss

 PROBLEM

Your city has a single bookstore which sells

books at a price of Rs. 20 and average cost of
Rs. 11. Suppose the city eliminates restrictions
and new stores enter. Each additional book store
decreases the price of book by Rs. 2 and
increases the average cost by Re 1. Predict the
equilibrium number of book stores.
 MONOP. COMPTN AND
ECONOMIC EFFICIENCY
• Compare the long run eqm of monopolistically competitive industry and the
perfectly competitive industry
• In mono comp, equilibrium price > marginal cost. So, the value to
consumers of additional units of output exceeds the cost of producing those
units. Output could have been expanded
• We saw that monopoly power creates a deadweight loss, and monopoly
power exists in monopolistically competitive markets.
• Entry of new firms drives profits to zero in both perfectly competitive and
monopolistically competitive markets
• For the monopolistically competitive firm, output is below that which
minimizes average cost. The zero-profit point is to the left of minimum
average cost. Excess capacity is inefficient because average cost would be
lower with fewer firms.
 INEFFICIENCY

If output were expanded to the point where the demand curve intersects the
marginal cost curve, total surplus could be increased by an amount equal to
the yellow-shaded area in Figure (b).
 INEFFICIENCIES
• Under perfect competition, as in (a), price equals marginal cost,
but under monopolistic competition, price exceeds marginal
cost. Thus there is a deadweight loss, as shown by the yellow-
shaded area in (b).
• In both types of markets, entry occurs until profits are driven to
zero. Under perfect competition, the demand curve facing the
firm is horizontal, so the zero-profit point occurs at the point of
minimum average cost.
• Under monopolistic competition the demand curve is
downward-sloping, so the zero-profit point is to the left of the
point of minimum average cost.
• In evaluating monopolistic competition, these inefficiencies
must be balanced against the gains to consumers from product
diversity.
 CASE STUDY

• MONOPOLISTIC COMPETITION IN THE

MARKETS FOR COLAS AND COFFEE
 REFERENCE

• Pindyck and Rubinfeld, Chapter 12