Monopolistic competition describes a market structure with many small businesses that sell differentiated but similar products. While firms compete on price, they also engage in non-price competition through product differentiation, branding, and advertising. In the short run, firms maximize profits by producing where marginal revenue equals marginal cost. In the long run, free entry and exit causes average costs to equal prices as firms earn zero economic profit.

1. Monopolistic Competition
Ayyappan
13-501-005

2. Definition and history
 The model of monopolistic competition describes a common market
structure in which firms have many competitors, but each one sells a
slightly different product.
 Monopolistic competition as a market structure was first identified in the
1930s by American economist Edward Chamberlin, and English economist
Joan Robinson
 In the case of restaurants, each one offers something different and
possesses an element of uniqueness, but all are essentially competing for
the same customers.

3. Characteristics
• Many sellers and buyers
• Product differentiation
• Free entry and exit
• In Short Run
• In Long Run
• Advertisement and propaganda is a major feature
• Brand names

4. Many sellers and buyers
• The number of firms in monopolistic competition is fairly large. Each firm
produces or sells a close substitute for the product of other firms in the
product group or industry. Product differentiation is thus the hallmark of
monopolistic competition.
Product differentiation
•
The firms sell differentiated products. Product differentiation may be real
or imaginary. Real differentiation is done through differences in the
materials used, design, colour etc. Imaginary differences may be created
through advertisement, brand name, trade marks etc

5. There are three important forms of product
differentiation:
Differentiation by style or type
Differentiation by location – dry cleaner near home vs. cheaper dry cleaner
far away
Differentiation by quality – ordinary vs. gourmet chocolate or branded

6. Comparing perfect and monopolistic
competition
Perfect
competition
Monopolistic
competition
number of sellers
many
many
free entry/exit
yes
yes
long-run econ. profits
zero
zero
Comparing Perfect & differentiated
Monop.
identical
firm has market power? Competition yes
none, price-taker
the products firms sell
D curve facing firm
horizontal
downwardsloping

7. Comparing Monopoly and Monopolistic
competition
Monopoly
Monopolistic
competition
number of sellers
one
many
free entry/exit
no
yes
long-run econ. profits
positive
zero
firm has market power?
yes
yes
D curve facing firm
downward-sloping downward(market demand) sloping
close substitutes
none
many

8. Aspects
Monopolistic competition has two types of competition aspects viz.
• Price competition i.e. firms compete with each other on the basis of price.
• Non price competition i.e. firms compete on the basis of brand, product
quality advertisement.

9. Price determination
• Under monopolistic condition different firms produces different varieties of
product ,there for different prices for their own productwill be determined
in the market depending up on their respective demand and cost condition.
• under monopolistic competition the producer must take optimal adjustment
not only in the price charged and as regard as quantity of output sold but
also in the design of the product and the way in which he promotes the
sales

10. The Firm’s Short-Run Output and Price
Decision
 A firm that has decided the quality of its product and its
marketing program produces the profit-maximizing
quantity at which its marginal revenue equals its marginal
cost (MR = MC).
 Price is set at the highest price the firm can charge for the
profit-maximizing quantity.
 The price is determined from the demand curve for the
firm’s product.

11. Price and Output in Monopolistic
Competition
• .
– The firm produces the
quantity at which
marginal revenue
equals marginal cost
– and sells that quantity
for the highest
possible price.
– It makes an economic
profit (as in this
example) when P >
ATC.

12. Price and Output in Monopolistic
Competition
• Profit Maximizing
Might be Loss
Minimizing
– A firm might incur
an economic loss in
the short run.
– Here is an example.
– In this case, P <
ATC.

13. Long Run: Zero Economic Profit
 In the long run, economic profit induces entry.
 And entry continues as long as firms in the industry make an economic profit—as long
as (P > ATC).
 In the long run, a firm in monopolistic competition maximizes its profit by producing
the quantity at which its marginal revenue equals its marginal cost, 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.

15. Long run zero profit
• In the long run, equilibrium of a monopolistically competitive
industry, the zero-profit-equilibrium, firms just break even.
The typical firm’s demand curve is just tangent to its average
total cost curve at its profit-maximizing output.

16. Long run zero profit
Point of tangency
Quantity

17. (a) Effects of Entry
(b) Effects of Exit
Entry shifts the
existing firm’s
demand curve and
its marginal revenue
curve leftward.
MR
2
MR
1
D
2
D
1
Quantity
Exit shifts the
existing firm’s
demand curve and
its marginal revenue
curve rightward.
MR
1
MR D1
2
D
2
Quantity

18. The Role of Advertising
 In industries with product differentiation, firms advertise in order to
increase the demand for their products.
 Advertising is not a waste of resources when it gives consumers useful
information about products.
 Either consumers are irrational, or expensive advertising communicates
that the firm's products are of high quality.