Monopolistic competition is characterized by: - Many small firms producing similar but differentiated products, allowing some control over pricing. While firms have some pricing power, the market is highly elastic due to substitutes. - Free entry and exit into the market. Firms use advertising and product development to differentiate themselves and try to earn economic profits, but in the long-run normal profits are achieved as new entrants drive down prices. - The economic effects are less detrimental than monopoly but include some waste from excess capacity and non-price competition through advertising.

1. Monopolistic competition
Group 1

2. CONTENTS
 First approach
 Ice Cream
 Advertising pros and cons
 Price and output decisions
Short run
Long run

3. THEORY
Monopolistic competition is defined as a market structure characterized by:
 - A large number of firms,
- Products which are differentiated and not seen as perfect
substitutes by consumers,
- Some ability of sellers to set prices as they wish,
- Free entry to and exit from the market,
- Heavy reliance on non-price actions to differentiate one's
product.

4. NUMBER OF FIRMS
 The large number of firms in monopolistic competition implies
that the firms are small in comparison to the entire market.
Although they have some power over price (to the extent that
their products are differentiated), they do not have sufficient
power to retaliate if another firm changes its price. This is
the major distinction between this market form and oligopoly

5. DIFFERENTIATED PRODUCT
 The differentiated product sold by a firm in monopolistic
competition has some features that makes a customer prefer it
over the available similar products of other firms. The features
may be physical or created by advertising. The power of any firm over price stems from
this very fact that products are not perfect substitutes. Non-price actions are necessary
to make the products differentiated.

6. ENTRY TO MARKET
 No barriers to entry or exit exist in monopolistic competition.
However, the need to make one's product differentiated may
require non-price action, which, if unsuccessful, would drive
the firm out of the market.

7. DEMAND
 The demand of a firm in monopolistic competition is down sloping because of the
preference of customers for the features of the differentiated product. However, because
there are many close (if not perfect) substitutes readily available, the demand is highly
elastic. Graphically, this means that the demand in monopolistic competition is flatter
than in monopoly.

8. PROFIT
 The profit of a firm in monopolistic competition is determined
in the same fashion as in any other type of market by finding the optimum quantity
where marginal revenue intersects marginal cost. This optimum level of output, in turn,
determines the price charged (on the demand curve) and average unit cost (on the
average total cost curve). The profit is the excess of total revenue area over total cost
area.

9. LONG RUN EQUILIBRIUM
 The long run equilibrium of a firm in
monopolistic competition is where demand is
tangent to the average total cost curve. There
is no profit. Should there be a profit (if
demand is above the average total cost curve),
firms would enter the market and drive the
demand down. And should there be a loss
(when demand is below average total cost),
firms would leave the market and push
demand up. Firms may, however, retain some
profits by using more non-price action.

10. ECONOMIC EFFECT
 The economic effect of monopolistic competition is an overall
undesirable loss of allocative and productive efficiency: the
customer pays more and is able to buy less than in perfect
competition. However, the effect is not as serious as in
monopoly and the differentiated products provide a much sought diversity.
Nevertheless, some waste is present in excess
capacity and in use of non price competition.

11. NON-PRICE ACTION
 Non price action of firms in monopolistic competition consists
primarily in either:
- Product development.
- Advertising.
Product development is sometimes only cosmetic to give the
illusion of novelty. Another danger stems from excessive
diversity which may confuse consumers.

12. ADVERTISING - ARGUMENTS IN
FAVOR
 Some of the arguments in favor of advertising are
- advertising is informative,
- advertising increases sales and permits economies of scale,
- advertising increases sales and contributes to economic
growth,
- advertising supports the media,
- advertising increases competition and lowers prices.

13. ADVERTISING - ARGUMENTS AGAINST
 Some of the arguments against advertising are
- Advertising is not informative but competitive,
- The economies of scale are illusory,
- Advertising raises the cost curve,
- Advertisers may use their influence to bias the media,
- Advertising is used as an entry barrier, and
- Advertising is not a productive activity.

14. Many small sellers
 The very large number of small firms in monopolistic competition.
 Collection of similar products.
 The freedom to set prices without engaging in strategic decision.
 Firm's actions have a negligible impact on the market.
 Many factors affect Monopolistic Competition market structure support at market
equilibrium.

15. Haagen-Daz
Premium ice cream -> Earned considerably
economic profit.
The market started to be crowded.