Monopolistic Competition

Chapter 14

Economics 3ed: Global and Southern African Perspectives © 2020 1

Main ideas
After studying this chapter, you will be able to:

• Define and identify monopolistic competition

• Explain how a firm in monopolistic competition determines its price and output
in the short run and the long run
• Explain why advertising costs are high and why firms use brand names in a
monopolistically competitive industry

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What is Monopolistic Competition?
Most real-world markets: competitive, but not perfectly competitive – firms have some
power to set their prices (like monopolies).

This type of market = Monopolistic Competition, characterised by:

• Large number of firms:
o Small market share
o Ignore other firms
o Collusion is impossible
• Product differentiation
• Competing on quality, price and marketing
• Entry and exit:
o No barriers to entry  zero long-run economic profit

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Price and Output in Monopolistic
Competition
Short-Run output and price decision
• Firm in monopolistic competition
makes its Q and P decision just like a
monopoly firm
• Goal: maximise economic profit –
where MR = MC

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Price and Output in Monopolistic
Competition
Profit maximising might be loss
minimising
• Large economic profit is not inevitable.
• Firm might face D that is too low for it
to make an economic profit

Economics 3ed: Global and Southern African Perspectives © 2020 5

Price and Output in Monopolistic
Competition
Long run: Zero economic profit
• No barriers to entry:
o If firms are making economic
profit, other firms have incentive
to enter
o When all firms are making zero
economic profit: no incentive for
new firms to enter
o If firms incur economic losses,
exit will occur

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Price and Output in Monopolistic
Competition
Monopolistic competition and perfect competition

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Product Development and Marketing
Product development
• Profit-maximising product
development
o Balance cost and revenue from
development at the margin
• Efficiency and product development
o Efficiency when MSB of a
new/improved product = MSC:
Advertising
• Advertising ensures consumers know
about firm’s differentiated product
• Advertising expenditure:
o Increases TFC but can decrease
ATC;
o Changes demand for product

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Product Development and Marketing

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Product Development and Marketing
Using advertising to signal quality
• Advertising is a signal to the consumer of a high-quality product
Brand Names
• Provide information to consumers about quality of a product
• Act as an incentive to the producer to achieve a high and consistent quality standard
Efficiency of advertising and brand names
• To the extent that advertising and brand names provide consumers with information
about the precise nature of product differences and about product quality, they
benefit the consumer and enable a better product choice to be made

Economics 3ed: Global and Southern African Perspectives © 2020 10