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. 
Visit the Student Online Learning Center for Chapter 11 for extra help with the issues we discussed today.



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this page is maintained by Reed Fisher
last updated March 25, 2005