Monopolistic Competition Overview

Monopolistic Competition

• A market structure characterized by a large number of firms competing, with each producing a differentiated product
• Firms compete on product quality, price, and marketing
• Firms are free to enter and exit the industry

Assumptions of Monopolistic Competition

• Many firms in the market
• Firms sell differentiated products, giving them some monopoly power
• Market demand curve becomes the firm's demand curve
• Many buyers must accept the firm's price
• Firms face a downward-sloping demand curve
• For each firm, price (P) is greater than marginal revenue (MR)
• Firms maximize profits where marginal revenue equals marginal cost (MR = MC)
• Profits or losses occur only in the short-run
• No barriers to entry into the market
• Free entry or exit in the long-run

How Monopoly Arises

• Product differentiation

Price Setter

• A firm sets the market price based on the market demand curve
• Example: Tim Hortons or Starbucks

Large Number of Firms

• Small market share

Product Differentiation

• A firm creates a slightly different product compared to competitors
• Example: Big Mac vs. Whopper

Competing on Quality, Price, and Marketing

• Quality: Firms can charge more for higher quality products (e.g., Keg Steak vs. Smitty's Steak)
• Price: Firms producing higher quality products can charge a premium price. (e.g., McDonald's Coffee vs. Starbucks Coffee)
• Marketing: Firms in monopolistic competition must market their products to differentiate them from competitors. (e.g., Pizza Hut vs. Dominoes; pharmaceutical companies advertising name-brand drugs versus generic options)

Entry and Exit

• No barriers to entry or exit
• New firms enter when current firms are making profits
• Old firms exit when current firms are making losses

Price and Output in Monopolistic Competition

• Firms in monopolistic competition act similarly to monopolies in the short run
• Economic Profit in the Short-Run: Graph on page 310 of the textbook
• Economic Loss in the Short-Run: Graph on page 311 of the textbook
• Long-Run Output and Price Decision: Long run: firms earn zero economic profits; profit-maximizing quantity occurs where price (P) equals average total cost (ATC)
• Firm's Costs: Costs curves do not change. Demand and MR curves shift inward with new products by other firms
• Graph on page 311 of textbook

Monopolistic Competition and Perfect Competition

• In the long run, a monopolistically competitive firm will produce less and charge a higher price than a perfectly competitive firm.

Excess Capacity

• A firm produces a quantity less than the minimum of average total cost (ATC), meaning it operates below its efficient scale
• MES (minimum efficient scale): the quantity at which long-run average cost (LRAC) is minimized
• MC firms produce less than minimum efficient scale (MES) in Long-Run; unless...
• Graph on page 312 of the textbook

Markup

• The difference between price (P) and marginal cost (MC)
  • Markup = (P - MC)
• Graph on page 312 of the textbook

Monopolistic Competition Efficiency

• Inefficient: Produces less than the minimum efficient scale (MES) in the long-run

Perfect Competition Return

• Possibly, if consumers view products as perfect substitutes, demand and MR curves rotate/become flatter until P = MR = AR = perfectly elastic demand curve

Product Development and Marketing

• Product Development: Profit-maximizing product development, efficiency, and product development
• Advertising: Fixed costs, shifting Average Fixed Cost (AFC) and Average Total cost (ATC) upward
• Graph on page 315 of the textbook
• Change in demand: If one firm's advertising is successful in acquiring other firms' customers, its demand increases and other firms face decreased demand that also makes their demand curves more elastic. Graph on page 316 of the textbook