- A market in which many firms produce similar goods or services but each maintains some independent control of its own price.
- 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
- 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
- Low Entry Barriers
- The presence of low barriers to entry.
|Behavior of Monopolistic Competition
A. Product Differentiation.
B. Brand Loyalty
- 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.
C. Short-Run Price and Output
- 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.
D. Entry and Exit
- 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.
E. No Long-Run Profits
- 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.
- In the long run, there are no economic profits in monopolistic competition.
- 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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