3.4 - monopolistic competition

Question 1

Characteristics of Monopolistically Competitive Markets

Answer 1

1) Many Sellers
2) Product Differentiation
3) Low barriers to entry and exit
4) Non-price competition
5) Limited but some price control
6) Imperfect information

Question 2

monopolistic competition -Limited Price Control

Answer 2

While firms have some degree of pricing power due to product differentiation, they face competition from other firms offering similar products. As a result, they cannot significantly raise prices without losing customers.

Question 3

Differentiated products

Answer 3

• Each firm produces a product that is similar but not identical to the products of its competitors. This product differentiation allows firms to have some control over the price they charge.
• These differences can be based on branding, quality, design, or other factors.

Question 4

Non-Price Competition

Answer 4

Firms engage in non-price competition to attract customers. This includes advertising, product design, branding, and customer service.

Question 5

Profit maximising equilibrium

Answer 5

• In the short run, firms can make supernormal profits, losses or normal profits. However, due
  to the lack of barriers to entry/exit, firms can only make normal profits in the long run. This is
  shown by the diagram.
• Firms are assumed to be short run profit maximisers, producing at MC=MR1 in the short run.
• As a result, they produce Q1 at price P1 and make a supernormal profit of the shaded area.
• However, in the long run, new firms will enter the industry as they know that supernormal profits are being earnt.
• This will cause demand for the individual firm to decrease and therefore the AR and MR curves will shift to the left.
• The firm will produce where MC=MR2 at
  P2Q2.
• At this point, AC=AR2 and so the firm is making normal profits.
• If the firm was making a loss, firms would leave the industry and thus demand for the individual firm would increase as they have less competition.
• This would lead to normal profits in the long run

Question 6

Limitation of monopolistic competition model

Answer 6

• The limitation of this model is that information may be imperfect and so firms will not enter the market as predicted as they are unaware of the existence of abnormal profits.
• Also, firms are likely to be different in their size and cost structure as well as in their products, which
  may allow some firms to maintain supernormal profits because firms cannot compete on
  equal terms.

Question 7

Efficiency

Answer 7

● Since they can only make normal profit in the long run, AC=AR and since they profit maximise, MR=MC. Therefore, the firm will not be allocatively or productively efficient, as MR does not equal AR so AC cannot equal MC and AC cannot equal
MR.

● They are likely to be dynamically efficient since there are differentiated products and so know that innovative products will give them an edge over their competitors
and enable them to make supernormal profits in the short run.
- However, since the
firms are small they may struggle to receive finance or have the retained profitsnecessary to invest.

● In monopolistic competition compared to perfect competition, less is sold at a higher price and firms may not necessarily be producing at the lowest cost.
- However, the market will offer greater variety and may be able to enjoy some
degree of economies of scale.