Monopolistic competition is characterized by many small sellers offering differentiated products. Entry and exit of firms is easy in the short run. Firms practice non-price competition through product differentiation and branding. In the short run, firms maximize profits where marginal revenue equals marginal cost. In the long run, firms earn only normal profits as barriers to entry are low, attracting new entrants. While prices are higher than perfect competition, consumers benefit from variety.

1. CHAPTER 4
MONOPOLISTIC COMPETITION

2. CHARACTERISTICS
1) Many small sellers
2) Differentiated product
3) Easy entry and exit
4) Practice non-price competition
5) Limited control over its price

3. DEMAND & REVENUE
 Good slightly differentiated →
firm has some influence/control
over P → downward sloping dd
curve & very elastic → bec the
large number of firms and
closeness of substitutes.
 Bec P is not constant → D=P=AR
but AR ≠ MR

4. Demand & MR Curve

5. SHORT-RUN EQUILIBRIUM
 Equil (max profit): MC = MR
 In SR, firms can earn 3 types of
profits.
 Diagrams are the same as in
monopoly
a) Supernormal Profit
 TR > TC
 AR > AC

6. b) Normal Profit
 TR = TC
 AR = AC
b) Subnormal Profit
 TR < TC
 AR < AC

7. LR EQUILIBRIUM
 Firms get only normal profit bec no
barrier to entry.
 Stage I – gets supernormal profit in
SR → attract new firms to enter →
firms ↑ non-P competition & prodn →
S ↑, cost ↑ & D/P ↓ → revenue ↓
 Stage II – gets normal profit only →
no new firms attracted to enter
 LR equil: MR = SMC = LMC

8. LR Equilibrium
Revenue,
Cost (RM)
SMC1
SAC1 LMC LAC
P1 SMC2
C1 SAC2
C2=P2
D1=P1
E2 D2=P2
MR2 MR1
0 Q1 Q2 Quantity

9. COMPARISON WITH PERFECT
COMP.
 Price → PMC > PPC
 Q → QMC < QPC
 AC → ACMC > ACPC → allocation of
resources is less efficient in MC

10. PRODUCT VARIATION &
SELLING EXPENSES
 Firms slightly change characteristics of
the product to attract buyers.
 Advertisement is used → selling
expenses ↑.
 Product variation & selling exp can ↑
sales and profits but cost also ↑.
 If MR > MC, firms can ↑ exp on
product variation until MC = MR.

11. EFFECTS OF ADVERTISING IN
MONO. COMP.
Revenue,
Cost (RM)
MC
AC2
P2
P1
AC1
C2
E2 D2=P2
C1
E1
D1=P1
MR1 MR2
0 Q1 Q2 Quantity

12. ECONOMIC INEFFICIENCY
 Firms produce at o/p level where P
> MC.
 However, deadweight loss in MC is
not as large as in monopoly bec D
curve is more elastic.
 In LR, firm does not produce o/p at
min AC.
 However, consumers gain from
product differentiation (wide variety
of products)