Monopolistic Competition

Topics to be Discussed Characteristics of Monopolistic Competition Short & Long-run Equilibrium Comparison with Perfectly Competitive Equilibrium Efficiency Considerations 2

Characteristics of Monopolistic Competition Many firms Free entry and exit Differentiated but highly substitutable products (hence conjectural variation is close to zero, if not exactly zero) Amount of monopoly power depends on the degree of differentiation) The greater the consumer preference towards differentiated product, the higher the price 4

A Monopolistically Competitive Firm in the Short and Long Run $/Q Short Run $/Q Long Run MC AC MC AC DSR MRSR QSR PSR DLR MRLR QLR PLR Quantity Quantity 12

A Monopolistically Competitive Firm in the Short and Long Run Short-run Downward sloping demand--differentiated product, demand is relatively elastic--good substitutes MC=MR < P => Firm makes economic profits Long-run Profits will attract new firms to the industry (no barriers to entry) No economic profit (P = AC), but P > MC => some monopoly power 13

Comparison of Monopolistically Competitive Equilibrium and Perfectly Competitive Equilibrium Perfect Competitive Firm Monopolistically Competitive Firm $/Q $/Q Deadweight loss MC AC MC AC DLR MRLR QMC P QC PC D = MR Quantity Quantity 17

Monopolistic Competition and Economic Efficiency The monopoly power (differentiation) yields a higher price than perfect competition. Although there are no economic profits in the long run, the firm is still not producing at minimum AC and excess capacity exists. Variety in closely substitutable products, monopolistically competition offers to consumers to choose from, is also a dynamic efficiency gain to the society. 18