3.5 Monopolistic competition

Question 1

Define monopolistic competition

Answer 1

A market structure which resembles both monopoly and perfectly competitive market

Question 2

How does monopolistic competition resemble a monopoly?

Answer 2

• Each firm faces a downward sloping demand curve due to slightly different products (partial not perfect substitutes)
• Each firms MR curve is below their AR curves

Question 3

How does monopolistic competition resemble perfect competition?

Answer 3

• Lots of buyers and sellers
• No barriers to entry / exit
• New entrants making abnormal profits in the long run impossible to achieve

Question 4

How do firms profit maximise in the short run? - Monopolistic competition

Answer 4

• Very similar to a monopoly
• AR curve is for just one firm, as opposed to the whole market
• Due to slightly different products, the AR curve is more elastic

Question 5

How do firms profit maximise in the long run? - Monopolistic competition

Answer 5

The absence of barriers to entry in the LR is of great importance

• New firms entering causes AR to shift leftwards and forms a tangent to AC (removes abnormal profit)
• Total sales revenue and total costs are shown by OQ₁BP₁
• NOTE: the point of tangency between AR and AC is directly above point A (profit max)