2.10. Monopolistic Competition

Question 1

Monopolistic Competition Assumptions

Answer 1

1) Many buyers and many sellers.
2) Products are differentiated (usually through advertising / branding).
3) There are no barriers to entry / exit.
4) Each firm faces a downward sloping demand curve that is relatively price elastic.
5) Firms are profit maximisers (produce at output level where MC = MR)

Question 2

Monopolistic Outcomes

Answer 2

• Only normal profits (AR = AC) can be made in the LR

- It is possible to make abnormal profits (AR > AC) in the SR

Question 3

Monopolistic Competition Examples

Answer 3

• Restaurants (see book page 166)
• Coffee shops
• Hotels
• Bars
• Hairdressers
• Taxi companies
• Clothing shops
• TV networks / “on-demand”

Question 4

Monopolistic Competition in the short-run DIAGRAM

Answer 4

• y-axis: costs / revenue
• x-axis: output
• normal MC and AC curve
• downward sloping demand = AR curve
• downward sloping MR curve that becomes negative
• demand = AR curve overlaps the AC curve
• abnormal profits at the quantity where MC = MR
• the area of the graph where it is higher than the AC curve and below the D = AR curve is the abnormal profit

Question 5

Monopolistic Competition in the long-run DIAGRAM

Answer 5

• y-axis: costs / revenue
• x-axis: output
• normal MC and AC curve
• downward sloping demand curve
• downward sloping MR curve that becomes negative
• D = AR curve touches AC curve is at the quantity where MC = MR

Question 6

Monopolistic Competition Advantages

Answer 6

• Low barriers to entry makes the this market structure more “contestable”
• Differentiation leads to choice / diversity, which increases consumer utility
• Competition can lead to x-efficiency
• Dynamic efficiency is possible (owing to abnormal profits and low barriers to entry)
• More productively efficient than monopoly
• More allocatively efficient than monopoly

Question 7

Monopolistic Competition Disadvantages

Answer 7

• Allocative inefficiency occurs (P > MC) in SR and LR
• Productive inefficiency occurs (produce above minimum AC) in SR and LR
• Market saturation may reduce scope for economies of scale
• Spending on differentiating products (e.g. advertising / packaging) can be a wasteful use of resources
• B to E are likely to exist:
• • Adverts
• • Brand loyalty
• • Difference in product quality / reviews
• In reality, firms can make abnormal profits in the LR

Question 8

Monopolistic Competition Efficiency

Answer 8

• In the short and the long run the firm is inefficient.
• This is because it operates on but above the minimum point of its average total cost curve resulting in a situation of excess capacity.