3.4.3: Monopolistic Competition

Question 1

What is monopolistic competition?

Answer 1

A realistic type of perfect competition.

Question 2

What are the characteristics of monopolistic competition?

Answer 2

-Many buyers & sellers (so no single firm can greatly influence the market).
-Differentiated, non-homogenous goods (so firms have some price setting power).
-Low barriers of entry/exit (not costless).

Question 3

Short Run Monopolistic Competition Graph:

Answer 3

Question 4

Long Run Monopolistic Competition Graph:

Answer 4

Question 5

What is the difference in profit between short term and long term?

Answer 5

In short term, supernormal profit can be made. In long term, only normal profit can be made.

Question 6

(Monopolistic competition) In the short term, are firms:
-Allocatively efficient?
-Productively efficient?
-Dynamically efficient?

Answer 6

-No.
-No.
-Yes: firms can differentiate their products and innovate.

Question 7

(Monopolistic competition) In the long term, are firms:
-Allocatively efficient?
-Productively efficient?
-Dynamically efficient?

Answer 7

-No.
-No.
-Yes: firms can differentiate their products and innovate.

Question 8

(Monopolistic competition) Why are firms unable to make supernormal profit in the long run?

Answer 8

The short term supernormal profit incentivises firms to join the market, which is easy due to low barriers of entry.
Demand shifts inwards (and is more elastic), and firms have to take a lower price.
Therefore, only normal profit is made in the long run.

Question 9

How can firms continue to make supernormal profit in monopolistic competition?

Answer 9

Differentiating their products & innovating.