Chapter 17

MONOPOLISTIC COMPETITION

Prepared By:
Adarsh Menon
Ankur panchal
Ashish Panchal
Deval Panchal
 3 Attributes of Monopolistic
Competition
• Many sellers

• Product differentiation

• Free entry

• FOR example : Markets with Books, CDS,

Movies etc.
 THE MONOPOLISTICALLY COMPETITIVE
FIRM IN THE SHORT RUN
• Monopolistic competitor like monopolists,
maximize profit by producing at which
marginal revenue equals marginal cost.
• The firm in figure 1 makes profit because at
this quantity price is above average total cost.
• The firm in figure 2 makes profit because at
this quantity price is below average total cost.
 Figure 1
 Firms makes profit
Price

MC

ATC
Price

Average
Total cost Profit DEMAND
MR

0
Profit maximizing Quantity
quantity
 Figure 2
 Firms makes losses
Price

MC

Price
ATC

Average
losses
Total cost

MR DEMAND
0
Loss minimizing Quantity
quantity
 THE LONG RUN EQULIBRIUM
• In a monopolistically competitive market, if some
firms are making profit, new firms enter and the
demand curves for the incumbent firms shift to
the left.
• Similarly, if some firms are making profit, old
firms exit and the demand curves for the
remaining firms shift to the right.
• Because of this shift in demand curve a firms find
itself in the long run equilibrium shown in figure-
3.
• In this case, price equals to average total cost and
the firm earn zero profit.
 Figure 3
 A Monopolistic competitive in the in long run
Price

MC

Price
ATC

Average
Total cost

MR DEMAND
0
Profit maximizing Quantity
quantity
 TWO CHARACTERISTIC OF THE LONG
RUN EQUILIBRIUM
• As in monopoly market, price exceed marginal
cost. This conclusion arises because profit
maximization requires marginal revenue to
equal marginal cost and because the
downward sloping demand curve makes
marginal revenue less than the price.
• As in a competitive market, price equals
average total cost. This conclusion arises
because free entry and exit drive economic
profit to zero.
Monopolistic v/s perfect competition firm
• Figure-4 shows the long run equilibrium in a
monopolistically competitive market and
Figure-s shows the perfectly competitive
market.
• First difference is that perfectly competitive
firm produces at the efficient scale, where
average total cost is minimized. By contrast
the monopolistically competitive firm produce
at less than the efficient scale.
 Monopolistic v/s perfect competition
firm
• Second difference is that the price is equal
marginal cost under perfect competition but
price is above marginal cost under
monopolistic competition.
 Figure 4
 Monopolistically competitive Firm
Price
MC

Markup
Price ATC

Average
Total cost
MR DEMAND

0
Quantity Efficient Quantity
produced scale

Excess capacity
 Figure 5
 Perfectly competitive Firm
Price
MC

ATC

P=MR
P=MC
(demand
curve)

0
Quantity Efficient Quantity
produced
= scale