•Profit Maximization Q & P
–Monopolistic competition is a market with the following characteristics:
– A large number of firms.
– Each firm produces a differentiated product.
– Firms compete on product quality, price, and marketing.
– Firms are free to enter and exit the industry.
Large Number of Firms 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 not so much to the action of a particular
•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.
–Differentiated products must be marketed using advertising and packaging.
Entry and Exit
–There are no barriers to entry in monopolistic competition, so firms cannot earn an economic
profit in the long run. Profit Maximization: MR=MC. The firm produces the quantity at which marginal revenue equals
marginal cost and sells that quantity for the highest possible price. It earns an economic profit (as
in this example) when P > ATC.
Long Run: Zero Economic Profit
–In the long run, economic profit induces entry.
–And entry continues as long as firms in the industry earn an economic profit—as long as (P >
–In the long run, Profit Maximization requires: MR = MC
–As firms enter the industry, each existing firm loses some of its market share. The demand for
its product decreases and the demand curve for its product shifts leftward.
–The decrease in demand decreases the quantity at which MR = MC and lowers the maximum
price that the firm can charge to sell this quantity.
–Price and quantity fall with firm entry until P = ATC and firms earn zero economic profit.
Monopolistic Competition a