Chapter 14 Monopolistic Competition WHAT IS MONOPOLISTIC COMPETITION

Chapter 14 Monopolistic Competition

WHAT IS MONOPOLISTIC COMPETITION? Monopolistic Competition is a market structure in which A large number of firms compete. Each firm produces a differential product. Firms compete on product quality, price and marketing. Firms are free to enter and exit the industry.

WHAT IS MONOPOLISTIC COMPETITION? Large Number of Firms Large number of firms like perfect competition. The large number of firms have three implications for the firms in the industry. Small Market Share In Monopolistic competition, firm’s output small relative to industry output. Limited power to influence price of its product. Each firm’s price can deviate from average price of other firms by only a relatively small amount.

WHAT IS MONOPOLISTIC COMPETITION? Ignore Other Firms Firm does not pay attention to one individual competitor. All firms are small, so no firm can dictate market conditions and no firm’s actions directly affect action of other firms. Collusion Firms in monopolistic competition would like to be able to conspire to fix a higher price – called collusion. Number of firms large, so coordination is difficult and collusion is not possible.

WHAT IS MONOPOLISTIC COMPETITION? Product Differentiation A firm practices product differentiation if it makes a product that is slightly different from the products of competing firms. A differentiated product is a close substitute but not a perfect substitute for the products of the other firms. Example: Adidas, Nike, Puma, Reebok all make differentiated running shoes. If Adidas increases price, it sells fewer shoes but does not disappear.

WHAT IS MONOPOLISTIC COMPETITION? Competing on Quality, Price and Marketing Product differentiation enables firms to compete in three areas: product quality, price and marketing. Quality The quality of a product is the physical attributes that make it different from the products of other firms. Quality includes design, reliability, etc. Price Due to product differentiation a firm in monopolistic competition faces downward-sloping demand curve.

WHAT IS MONOPOLISTIC COMPETITION? Marketing Because of product differentiation, a firm in monopolistic competition must market its product. Marketing takes two main forms: advertising and packaging. Entry and Exit Monopolistic Competition has no barriers to entry and exit so new firms can enter and exit. If there is economic profit new firms enter. If there is economic loss, loss making firms exit. In long-run equilibrium, all firms earn zeroeconomic profit.