Monopolistic Competition Characteristics of Monopolistic Competition What is

Monopolistic Competition Characteristics of Monopolistic Competition

What is monopolistic competition? � Relatively large number of sellers ◦ Each seller has a small market share and minimal control of market price ◦ No collusion—output restriction and price setting don’t occur ◦ Independent action—each firm’s pricing policy has minimal influence on rivals.

� Differentiated Products ◦ “unique” attributes—features, materials, design, workmanship ◦ Service ◦ Location (minimarts, gas stations, hotels) ◦ Branding and packaging ◦ Some control over price—sellers of favorable products may command slightly higher price

� Easy Entry and Exit ◦ Not as easy as pure competition (brand names, patents, trademarks) ◦ Most monopolistic competitors are small; economies of scale are few

� Nonprice Competition and Advertising ◦ The goal of nonprice competition is to make price less of a factor in consumer purchases ◦ If successful, nonprice competition shifts a demand curve to the right and makes it less (elastic/inelastic? ) ◦ Which market structure does the most advertising? ◦ Examples of monopolistic competition?

Monopolistic Competition: Price and Output � Demand curve is between monopoly and pure competition and the degree of price elasticity depends on the number of rivals and degree of differentiation. (More rivals, less differentiation—close to pure competition. ) � One educated guess as to where the firm will maximize profits? ?

MR = MC !! � Profits or losses are possible in the short run, but in the long run… � Only a normal profit! ◦ Economic profits lead to entry of new firms. �As new firms enter, the demand curve faced by the typical firm will shift to the left (more close substitutes. ) ◦ Economic Losses lead to exit of firms.

� Long Run Equilibrium: ATC hitting the demand curve at output where MR=MC. ◦ Real world complications: firms do consistently earn economic profits. �Rivals can’t duplicate the differentiation �Differentiation acts as a barrier (financial) to entry.

Economic Efficiency � Monopolistic competition is neither productively nor allocatively efficient. ◦ P>min. ATC ◦ P>MC

� Excess Productive Capacity—plant and equipment underused when firms produce at less than min. ATC. � Result: many monopolistically competitive industries are overcrowded with firms producing below optimal capacity (retail, hotel vacancies, restaurants, barber chairs. )

� Nonprice Competition ◦ In order to differentiate, firms advertise. �Fixed cost: increases ATC �Increases demand ◦ Differentiation provides consumers variety and satisfies diverse tastes. ◦ Differentiation may lead to product improvements and innovation.