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MONOPOLISTIC

COMPETITIVE MARKET

QUICK COMPARISON BETWEEN FOUR


MARKETS
Key
characteristics

Perfect
Competition

Monopolistic
Competition

Oligopoly

Monopoly

No. of Sellers

Large number of
sellers

Many sellers

Few sellers

One single seller

Price decision
(Price control)

Price taker
(no control over
P)

Price taker
(little control)
non-price
competition

Price maker
(some control)

Price maker
(complete control)

Type of product

Homogenous/
Identical

Slightly
differentiated

Homogenous/
Differentiated

Unique

Barriers to Entry

No barriers/ Easy
entry & exit

No barriers/ Easy
entry & exit

Difficult of entry &


exit

Completely
blocked for entry

Type of SR profit

Supernormal/
normal/
subnormal profi

Supernormal/
normal/
subnormal profit

Supernormal/
normal/
subnormal profit

Supernormal/
normal/
subnormal profit

Type of LR profit

Normal profit

Normal profit

Supernormal
profit

Supernormal
profit

Demand curve

Horizontal DD
curve, perfectly
elastic demand,
D=MR=AR=P

Downward
sloping (elastic)
P=AR=D>MR

Downward
sloping or kinked
D curve

Downward
sloping (inelastic)2
P=AR=D>MR

MONOPOLISTIC COMPETITION

Imperfect competition refers to market structures between


perfect competition and monopoly

In imperfectly competitive markets, there is more than one seller,


but still too few to create a perfectly competitive market

In addition, imperfectly competitive markets often violate other


conditions of perfect competition, such as the requirement of a
standardized product or free entry and exit

RELATIONSHIP TO OTHER MARKET MODELS

Monopolistic competition is similar to perfect competition in


that:

There are many buyers and sellers

There are no barriers to entry or exit

Monopolistic competition is similar to monopoly in that:

Each firm is the sole producer of a particular product


(although there are close substitutes)

The firm faces a downward sloping demand curve for its


product

MONOPOLISTIC COMPETITION

Monopolistic competition is a market structure with three


fundamental characteristics

Many buyers and sellers

Sellers offer a differentiated product

Sellers can easily enter into or exit from the market

Because it produces a differentiated product, a monopolistic


competitor faces a downward-sloping demand curve

When it raises its price a modest amount, quantity demanded will


decline (but not all the way to zero)
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DEMAND CURVE FACING A


MONOPOLISTICALLY COMPETITIVE FIRM

THE FIRMS DEMAND CURVE AND ENTRY AND


EXIT

Monopolistically
competitive

As firms enter a
monopolistically
competitive market,
the demand facing
a typical firm
declines and
becomes more
elastic.

MONOPOLISTIC COMPETITION IN THE


SHORT-RUN

Individual monopolistic competitor behaves very much like a


monopoly

Key difference is this

While a monopoly is the only seller in its market, a monopolistic


competitor is one of many sellers

When a monopolistic competitor raises its price, its customers


have one additional option
Can buy similar good from some other firm

Monopolist firms normally do not engage in price cutting


strategy
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A MONOPOLISTICALLY COMPETITIVE FIRM


IN THE SR-SUPERNORMAL PROFIT
Dollars

$70

1. Kafka services 250 homes


per month, where MC and
MR intersect . . .
A

MC
ATC
2. and charges
$70 per home.
d1

30

MR1 3. ATC at 250 units is less


than price, so profit per
unit is positive.

4. Kafka's monthly
profit$10,000is
the area of the
shaded rectangle.
250

Homes Serviced per Month

SHORT-RUN EQUILIBRIUM IN MC FIRM WITH


ECONOMIC PROFIT (SUPERNORMAL PROFIT)

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SHORT-RUN EQUILIBRIUM IN MC FIRM WITH


ZERO ECONOMIC PROFIT (NORMAL PROFIT)

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SHORT-RUN EQUILIBRIUM IN MC FIRM WITH


ECONOMIC LOSSES (SUBNORMAL PROFIT)

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MONOPOLISTIC COMPETITION IN THE


LONG-RUN

Under monopolistic competitionin which there are


no barriers to entry and exitthe firm will not
enjoy its profit for long

Entry will continue to occur, and demand curve will


continue to shift leftward

Under monopolistic competition, firms can earn


positive or negative economic profit in short-run

But in long-run, free entry and exit will ensure that each
firm earns zero economic profit (normal profit) just as
under perfect competition

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MONOPOLISTIC COMPETITION IN THE


LONG-RUN

In real world, monopolistic competitors often earn


economic profit or loss in the short-run

Butgiven enough timeprofits attract new entrants, and


losses result in an industry shakeout

Until firms are earning zero economic profit

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FIGURE 7: A MONOPOLISTICALLY
COMPETITIVE FIRM IN THE LONG RUN
In the long run, profit attracts entry,
which shifts the firm's demand
curve leftward.

Dollars

MC
ATC

$40

Entry continues until P = ATC


at the best output level, and
economic profit is zero.
d1

The typical firm


produces where
its new MR
crosses MC.

MR2
100

d2
250

MR1
Homes Serviced
per Month

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LONG-RUN EQUILIBRIUM IN A
MONOPOLISTICALLY COMPETITIVE MARKET
Entry continues
until economic
profit equals zero
for a typical firm.
This equilibrium
is often referred
to as a tangency
equilibrium.

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NONPRICE COMPETITION

If monopolistic competitor wants to increase its


output, it can cut its price

Move along its demand curve

Any action a firm takes to increase demand for its


outputother than cutting its priceis called nonprice competition

Examples include better service, product guarantees, free


home delivery, more attractive packaging

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NONPRICE COMPETITION

Non-price competition is another reason why


monopolistic competitors earn zero economic profit
in long-run

All this non-price competition is costly

Must pay for advertising, for product guarantees, for better


staff training
Costs must be included in each firms ATC curve, shifting it
upward

None of this changes conclusion that monopolistic


competitors will earn zero economic profit in longrun
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PRODUCT DIFFERENTIATION AND ADVERTISING

Monopolistically competitive firms may receive


short-run economic profit from successful product
differentiation and advertising.

These profits are, however, expected to disappear


in the long run as other firms copy successful
innovations.

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LOCATION DECISIONS

Monopolistically competitive firms often locate near


each other to appeal to the median customer in a
geographical region. (e.g., fast food restaurants and
car dealerships)

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IMPERFECT INFORMATION

Brand name identification serves as a signal of


product quality. Customers are willing to pay a
higher price for products produced by firms that
they recognize.

Product guarantees also serve as a signal of


product quality

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MONOPOLISTIC COMPETITION AND EFFICIENCY

As the number of firms rises, a monopolistically


competitive firms demand curve becomes more
elastic.

As the number of firms in a market expands, the


market approaches a perfectly competitive
market.

Thus, economic inefficiency may be smaller


when there is a large number of firms in a
monopolistically competitive market.

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