Monopolistic competition describes a market with many small businesses that sell differentiated but substitutable products. While firms have some control over prices due to product differences, barriers to entry are low and many competitors result in zero long-run profits. Each firm faces a downward-sloping demand curve and engages in non-price competition like advertising. In the short-run, firms can earn profits or losses, but in the long-run free entry and exit forces prices down to match average costs.

1. MonopolisticMonopolistic
CompetitionCompetition

2. Monopolistic Competition
Monopolistic competition theory was
developed in 1930s by the American
economist Edward Chamberlin. Monopolistic
competition is more realistic than either pure
competition or monopoly. It is a blending of
competition and monopoly.

3. Monopolistic Competition Defined
Monopolistic Competition refers to a market
organization in which there are many firms selling
closely related but not identical commodities.

4. Characteristics of monopolistic competition:
 There are many buyers and sellers in the market.
 Firms produce a non-homogeneous (differentiated) product.
 There is freedom of entry and exit into the market, i.e., barriers
to entry are low.
 Buyers and sellers have perfect knowledge, economic agents are
fully informed of prices and output in the industry.
 Non-price competition: Expenditure on advertisement and other
selling costs.

5. Key Implications
o Since products are differentiated, each firm
faces a downward sloping demand curve;
firms have limited market power.
o Free entry and exit, so firms will earn zero
profits in the long run.

6. Demand curve
As firms produce a differentiated product,
they will have a certain amount of market
power due to brand loyalty. Firms are
therefore not price takers, as they can raise
prices without losing all of their customers.
The demand curve will be downward
sloping, but relatively elastic due to the
number of close substitutes.

7. Demand curve

8. Short-run equilibrium of the firm
under monopolistic competition
It is possible that a firm operating in
monopolistic competition could earn:
abnormal profits,
normal profits or
make a loss.

9. Economic profit
£
QO Qs
AR = D
MC
AC
MR
Abnormal profits (AR>AC)
Ps
ACs

10. Normal profits (AR=AC)

11. Losses (AR < AC)

12. Long-run equilibrium of the firm
under monopolistic competition
The absence of barriers to entry allows firms to
enter the industry, this will occur if abnormal
profits are being earned. The entry of new firms
will shift the demand curve for any particular
firm to the left, as consumers demand moves
from one firm to another. The demand curve
will continue to shift to the left until it is
tangential to the average cost curve (AR=AC),
where normal profits are earned and there is no
incentive for further firms to enter the industry.

13. Long-run equilibrium of the firm
under monopolistic competition
ARL = DL
MRL
£
QO QL
PL
LRAC
LRMC

14. Monopolistic competition
Comparison with
perfect competition
(long run)

15. Q2
P2
DL under perfect
competition
Long run equilibrium of the firm under perfect and
monopolistic competition
£
QO
P1
LRAC
DL under monopolistic
competition
Q1

16. Monopolistic Competition
The Good (To Consumers)
Product Variety
The Bad (To Society)
P > MC
Excess capacity
Unexploited economies of scale
The Ugly (To Managers)
Zero Profits