1. What Is Monopolistic Competition?
2. The Firm’s Short-Run Output and Price Decision
3. Price and Output in Monopolistic Competition
4. Profit Maximizing Might Be Loss Minimizing
5. Long Run: Zero Economic Profit
6. Monopolistic Competition and Perfect Competition
7. Is Monopolistic Competition Efficient?
1 1. What Is Monopolistic Competition?
Monopolistic competition is a market with the following characteristics:
There are a large number of firms, with each firm
producing a differentiated product.
Firms compete on product quality, price, and marketing.
Large Number of Firms
The presence of a large number of firms in the market implies:
Each firm has only a small market share and therefore has limited
market power to influence the price of its product.
Each firm is sensitive to the average market price, but no firm pays
attention to the actions of the other, and no one firm’s actions directly
affect the actions of other firms.
Collusion, or conspiring to fix prices, is impossible.
Firms in monopolistic competition practice product differentiation, which
means that each firm makes a product that is slightly different from the
products of competing firms.
Competing on Quality, Price, and Marketing
Product differentiation enables firms to compete in three areas: quality,
price, and marketing.
Quality includes design, reliability, and service.
Because firms produce differentiated products,
each firm has a downward-sloping demand curve
for its own product. But there is a tradeoff between
price and quality.
Differentiated products must be marketed using
advertising and packaging.
2 Entry and Exit
There are no barriers to entry in monopolistic competition, so firms cannot
earn an economic profit in the long run.
2. Price and Output in Monopolistic Competition
Short-Run Economic Profit
A. A firm that has decided the quality of its product and its marketing program
produces the profit maximizing quantity at which its marginal revenue
equals its marginal cost (MR = MC).
a) Price is determined from the demand curve for the firm’s product and is the
highest price the firm can charge for the profit-maximizing quantity.
b) A firm in monopolistic competition can earn an economic profit in the short
run if: P > ATC. It operates much like a single-price monopolist.
B. Figure 1 shows a short-run equilibrium output and price for a firm in
C. Figure 2 shows a short-run equilibrium output and price for a firm making