Imperfect

Competition
 IMPERFECT COMPETITION
Most firms compete with other firms and have some degree of
market power because most markets are a form of IMPERFECT
COMPETITION.

We consider two types of imperfect competition:

MONOPOLISTIC COMPETITION
OLIGOPOLY
Imperfect Competition
Monopolistic Competition
[Competition among many]
 MONOPOLISTIC COMPETITION

It is a market structure where competition takes place among a large

number of sellers of differentiated products which are close substitutes of
each other.
Examples: Retailers/Hairdressers/Chemists

CHARACTERISTICS/Features:
A LARGE NUMBER OF FIRMS.
Each firm has a small share of the market and is unlikely to affect its rivals
greatly.

FREEDOM OF ENTRY: No barriers to entry.

The above are found also in Perfect Competition
 MONOPOLISTIC COMPETITION
CHARACTERISTICS:

PRODUCT DIFFERENTIATION: a real or an artificial differentiation. A real

differentiation means products have distinctive features whereas an
artificial differentiation means that products have different names only.
This confers them monopoly element and therefore are considered Mini-
Monopolists.
Each firm is faced with a downward sloping demand. Demand is likely to
be price elastic as there are many competitors.

Although there are many firms, there is only one in each location [local
monopoly]
 Monopolistic Competition
Characteristics:
Firms are assumed to be short-run profit maximizers. The sole goal of firms is to
maximize Economic Profit.
Firms earn abnormal profit in the short-run but only earn normal profit in the
long-run.
Since each firm is a mini-monopolist it has a certain degree of control over the
price it charges.
Since products are differentiated each firm engages in some form of
promotional activities. However it would of limited in comparison to Oligopoly
market.
Monopolistic Competition
Short-run Equilibrium
 MONOPOLISTIC COMPETITION
EQUILIBRIUM OF THE FIRM

SHORT RUN
Profit is maximised where MC = MR, MC cuts MR
from below at equilibrium point.
The firm can make supernormal profit in the short
run.

The more differentiated the product the greater the

potential supernormal profit.
Short-run equilibrium of the firm
under monopolistic competition
£ MC

AC

Ps E

F
ACs

AR = D

MR

O Qs Q
 Monopolistic Competition
Short-run Equilibrium

As shown in the previous slide the equilibrium of the firm takes place at a point
where MC=MR and MC cuts MR from below. So at this equilibrium point the firm
produces Oqs output and sells it at a price of Ops. The total revenue earned by
the firm is represented by the rectangle OPsEQs and the total cost incurred is
OACsFQe.
Since TR is larger than TC the firm earns economic profit indicated by the shaded
rectangle ACsPsEF.
The representative firm continues to earn abnormal profit in the short-run
because new firms cannot enter the market.
Monopolistic Competition
Long-run Equilibrium
MONOPOLISTIC COMPETITION
EQUILIBRIUM OF THE FIRM

LONG RUN
Supernormal profit will attract new firms enter into
the industry.

This will shift to the left the demand [AR] curve of

the established firm/s.

This will continue until only normal profit remains.

[see following slide]
Long-run equilibrium of the firm
under monopolistic competition
£
New firms entering
the industry reduce
demand for each
individual firm. LRMC

Price falls to PL
LRAC

PL E

ARL = DL

MRL

O QL Q
Monopolistic Competition
Limitations of the model
MONOPOLISTIC COMPETITION
LIMITATIONS OF THE MODEL:
THE FIRM MAY HAVE IMPERFECT KNOWLEDGE

NOT POSSIBLE TO PRODUCE AN AR CURVE FOR THE

INDUSTRY [because they produce a differentiated
product]

ENTRY MAY BE RESTRICTED [often because of

location]

THE THEORY CONCENTRATES ON PRICE & OUTPUT

DECISIONS [in reality firms also make decisions
about non-price competitions]
MONOPOLISTIC COMPETITION
PUBLIC INTEREST:

Compared to perfect competition,

monopolistic competition will result in:

LOWER OUTPUT
There is excess capacity of Q1 – Q2
Under-utilisation of capacity in the long run
£

LRAC

DL under monopolistic
competition

O Q1 Q2 Q
MONOPOLISTIC COMPETITION
PUBLIC INTEREST:

HIGHER PRICE

PRODUCTION COST IS ABOVE THE LEAST-

COST LEVEL

However the consumer benefits from variety

Long run equilibrium of the firm under perfect and
monopolistic competition
£
Higher price and lower output
(excess capacity) under LRAC
monopolistic competition

P1 E

P2 F
DL under perfect
competition

DL under monopolistic
competition

O Q1 Q2 Q
MONOPOLISTIC COMPETITION
PUBLIC INTEREST:
Compared to monopoly:
LOWER PRICES
GREATER COST EFFICIENCY
but
Monopoly may produce
ECONOMIES OF SCALE
MORE FUNDS FOR R&D