Monopolistic Competition content slideshow. Designed for the Economic A level qualification. Can be used in revision and in class. Subtopics: Intro to Mono Comp Mono Comp Equilibria Costs of Mono Comp

1. Monopolistic
Competition
Upper 6th Micro
Market Structures

2. Intro to Mono
Comp
Monopolistic Competition
Mr O’Grady

3. Intro to Mono Comp
Definition: Where a large number of small firms produce slightly differentiated
products
Shares some characteristics of perfect competition, mainly the absence of entry barriers
Also shares some characteristics of monopoly, especially in relation to branding and product
differentiation
Examples: Hairdressers or fast-food outlets
Assumptions:
No entry barriers: New firms can enter the market if they see SNPs being made
Though they will differentiate their product, so it won’t be a perfect substitute
Low concentration ratio: Due to the many firms operating in the market
A price change by one firm has little effect on the demand for its rivals’ products
Profit maximisation: Firms always produce where MR = MC
Product differentiation: A high degree of product variety and brand loyalty, maintained with
heavy advertising
Creates some level of market power and thus control over their individual prices and so individual firms
face a downward sloping AR curve
N.B. this is the main factor distinguishing monopolistic competition from perfect competition

4. Mono Comp
Equilibria
Monopolistic Competition
Mr O’Grady

5. Mono Comp Equilibria
Short Run Equilibrium: Same as monopoly. Firms can make supernormal profits and will
look to profit maximise (green rectangle). The market price is above the firm’s average
cost.
Allocatively inefficient (P > MC) and Productively inefficient (c > AC min)
There is a deadweight loss in the short run for mono comp! Total welfare is not maximised.
However: There is a lack of entry barriers in monopolistic competition
The existence of SNP indicates is only a short-run position, as new firms will soon enter the market to
compete for those profits
Quantity
C/R
AC
MC
D = AR
MR
qMon
pMon
cMon
DWL

6. Long Run Equilibrium: In the long-run, the market will adjust in so that firms can only make
normal profits
AC tangential to AR above MR = MC
Reasons:
New firms entry: attracted by the SNP and low barriers to entry firms enter the market to compete for those
profits
Hence there will be more substitutes available for the products of existing firms
So the AR curve for existing firms will shift to the left and become more elastic as there are now more substitutes,
It will not be perfectly elastic as there is product/brand differentiation
Increased advertising: As more firms enter the market, existing firms increase their advertising expenditure, in
order to defend their market shares
This shifts the AC curve upwards
N.B. this is not necessary for the firm to move to normal profit but instead accelerates the process
Quantity
C/R
AC
MC
D = AR
MRQ
c/p

7. Costs of Mono
Comp
Monopolistic Competition
Mr O’Grady

8. Costs of Mono Comp
Allocative inefficiency: At its optimum output the firm charges a price greater than marginal cost.
This is as the firm maximizes profits where MR = MC
Since the firm’s demand curve is downward sloping, AR will be above MR, and the firm will always charge a price
greater than MC.
Hence a net loss of welfare.
Productive inefficiency: The firms operate with excess capacity and average costs that are not minimised.
A monopolistically competitive firm will operate at a point where demand or price equals average cost in the long run.
For a PC firm this equilibrium condition occurs where the perfectly elastic demand curve equals minimum average
cost.
As the firm's demand curve is not flat but is downward sloping, the demand curve will be tangential to the average
cost curve (AR=AC) at a point to the left of its minimum and so costs aren’t minimised.
Dynamic inefficiency: Normal profits prevent firms from carrying out R&D.
No innovations can take place and costs can’t fall.
Selling costs: Producers under monopolistic competition are spending huge amounts on advertising and
publicity.
Much of this expenditure is wasteful from the social point of view. The producer can reduce the price of the product
instead of spending on publicity.
Loss of internal EoS: Under monopolistic competition, small market shares can mean there is little scope
for specialization or standardization.
This could see lower productivity and firms operate with higher average costs
Too much choice: Product differentiation practiced under this competition leads to increased costs.
It is argued that instead of producing many similar products, only a few standardized products should be produced.
This would ensure better allocation of resources and would promote economic welfare of the society.

9. Where next?
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