Monopolistic Competition
Monopolistic Competition
  • A market in which many firms produce similar goods or services but each maintains some independent control of its own price.
Structural Characteristics
  • A distinguishing structural characteristic of monopolistic competition is that there are “many” firms in the industry.  “Many” is somewhere between the “few” of oligopolies or the “hordes” that characterize perfect competition.
  • Low Concentration
    • Low concentration ratios are common in monopolistic competition.
    • Examples of monopolistic competition include banks, radio stations, health spas, apparel stores, and convenience stores.
  • Market Power.
    • Each producer in monopolistic competition is large enough to have some market power.
    • A monopolistically competitive firm confronts a downward-sloping demand curve.
  • Independent Production Decisions.
    • Modest changes in the output or price of any single firm will have no perceptible influence on the sales of any other firm.
    • The relative independence of monopolist competitors means that they don’t have to worry about retaliatory responses to every price or output change.
  • Low Entry Barriers
    • The presence of low barriers to entry.
Behavior of Monopolistic Competition
A.  Product Differentiation.
  • One of the most notable features of monopolistically competitive behavior is product differentiation - that is, features that make one product appear different from competing products in the same market.
B.  Brand Loyalty
  • Each firm only has a monopoly on its brand image.  It still competes with other firms offering close substitutes.
  • Brand loyalty makes the demand curve facing the firm less price-elastic.
  • Brand loyalty implies that consumers shun substitute goods even when they are cheaper.
  • Each monopolistically competitive firm will establish some consumer loyalty.
C.  Short-Run Price and Output
  • The monopolistically competitive firm’s production decision is similar to that of a monopolist.
  • As always, the profit-maximizing rate of output is desired  MR = MC.
D.  Entry and Exit
  • With low barriers to entry, new firms will enter the market if there is economic profit.
  • When firms enter a monopolistically competitive industry:
    • the market supply curve shifts to the right. 
    • the demand curves facing individual firms shift to the left.
E.  No Long-Run Profits
  • In the long run, there are no economic profits in monopolistic competition.
F.  Inefficiency
  • Monopolistic competition tends to be less efficient in the long run than a perfectly competitive industry.
  • Excess Capacity - Because of the industry-wide excess capacity in monopolistic competition, each firm is producing at a rate of output that is less than its minimum-ATC output rate.  Thus, the same level of industry output could be produced at lower cost with fewer firms.
  • Flawed Price Signals - Monopolistic competition results in both production inefficiency (above-minimum average cost) and allocative inefficiency (wrong mix of output).
Key Point 1:  In truly (perfectly) competitive industries, firms compete on the basis of price.

Key Point 2:  Imperfectly competitive firms engage in nonprice competition with the most prominent form of nonprice competition being advertising. 

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this page is maintained by Reed Fisher
last updated January 15, 2011