Economics

Monopolistic Competition

Monopolistic Competition is a form of imperfect competition in which one selling/buying firm dominates the market. This firm regulates the prices in the market as no other firm is large enough to make significant changes to price.

  • Characteristics:
    • Large number of firms in the industry
    • May have some element of control over price due to the fact that they are able to differentiate their product in some way from their rivals
    • Entry and exit from the industry is relatively easy
    • Consumer and producer knowledge is imperfect
  • Diagrammatic representation

Monopolistic Competition 1

  • This is a short run equilibrium position for a firm in a monopolistic market structure.
  • If the firm produces Q1 and sells each unit for £ 1.00 on average with the cost (on average) for each unit being 60p, the firm will make 40p x Q1 in abnormal profit.
  • We assume that the firm produces where MR = MC (profit maximising output). At this output level, AR>AC and the firm makes abnormal profit.
  • Marginal Cost and Average Cost will be the same shape. However, because the products are differentiated in some way, the firm will only be able to sell extra output by lowering price.
  • Since the additional revenue received from each unit sold falls, the MR curve lies under the AR curve.
  • The demand curve facing the firm will be downward sloping and represents the AR earned from sales.

Monopolistic Competition 2

 

  • Because there is relative freedom of entry and exit into the market, new firms will enter encouraged by the existence of abnormal profits. New entrants will increase supply causing price to fall. As price falls, the AR and MR curves shift inwards as revenue from each sale is now less.

Monopolistic Competition 3

  • The existence of more substitutes makes the new AR (D) curve more price elastic. The firm reduces output to a point where MC = MR (Q2). At this output AR = AC and the firm will make normal profit.
You might be interested in  Monopoly

 

Monopolistic Competition 4

  • This is the long run equilibrium position of a firm in monopolistic competition
  • Example:

Monopolistic competition can be seen in the fast food industry.

  • There is large number of restaurant chains (mcdonalds, wimpys, kfc, etc.)
  • All services are basically the same, but are marketed differently (product differentiation)
  • There exists a perception that some fast food restaurants must be better than others ( imperfect knowledge)

Read about:  Perfect CompetitionGross Domestic Product, Oligopoly

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