1. Monopolistic Competition

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

3. 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

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

5. 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

6. 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

7. 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