Characteristics of Monopolistic Competition
- Many firms
- Differentiated products which leads to non-price competition
- Low barriers to entry (easy for firms to enter and exit the market)
- Limited market power
- Rely heavily on branding and advertising
- Normal profit in the long-run
- Not allocatively efficient
- Monopolistic competition is like a mix between perfect competition and monopolies.
- Each firm has a really small monopoly in a large, perfectly competitive market.
Advertising and Branding
- Because products are so similar, firms must attempt to differentiate their products as much as possible with marketing.
- Obtaining loyal customers leads to higher market power and the ability to raise price.
Examples of Marketing Strategies
- Packaging and brand name
- Service quality
- Location
- Commercials
Graphing Monopolistic Competition
Key Components
- Differentiation means MR is still not equal to demand, but more firms offer substitutes so demand is more elastic.
- Abnormal profits and losses only in the short run.
- Normal profit in the long run.
- For perfect competition, the demand curve is perfectly elastic.
- For a monopoly, the demand curve is very inelastic.
- For monopolistic competition, the demand curve is elastic.
Abnormal Profits in the Long Run and Short Run
- If a firm is making abnormal profits in the short run, others will notice this and enter the market.
- As more firms enter the market, the demand for a single firm reduces, causing the demand curve to shift to the left.
- Eventually in the demand curve shifts to the left as more firms join until they are making normal profits.
Losses in the Long Run and Short Run
In a firm is making losses in the short run, the firms will begin leaving the market.
As more firms leave the market, the demand for a single firm increases, causing the demand curve for the firm to shift to the right.
The demand curve shifts right until the firms are back to making normal profits.
Market Failure in Monopolistic Competition
- In monopolistic competition there is always some welfare loss, even in the long run.
- This is because there is not allocative efficiency (MC = AR) and there is not productive efficiency (MC = AC).
- Governments don't intervene to make fix this welfare loss as then firms would no longer be making normal profit.
- Additionally, monopolistic competition gives consumers some choice.