3.5.6 - Monopolistic Competition

Question 1

Why is monopolistic competition particularly interesting?

Answer 1

It resembles both perfect competition and monopoly.

Question 2

How does monopolistic competition resemble perfect competition?

Answer 2

Large number of firms in the market.
No barriers to entry / exit in the long run.
Firms are attracted by supernormal profit in the short-run and compete away supernormal profit for others.

Question 3

How does monopolistic competition resemble a monopoly?

Answer 3

Each firm faces a downward-sloping demand curve.
Each firm produces a different, non-homogeneous good which are partial but not perfect substitutes of one another.
The marginal revenue curve is below the average revenue curve which is the demand curve.
Firms have price setting powers.

Question 4

What does the demand curve represent in monopolistic competition?

Answer 4

Demand for the output of the whole market rather than just one firm.

Question 5

What is different about the gradient of the demand curve in a monopoly compared to monopolistic competition?

Answer 5

The demand curve of a firm in monopolistic competition are more elastic than in a pure monopoly.

Question 6

Why can firms in monopolistic competition markets not make supernormal profit in the long-run?

Answer 6

The lack of entry/exit barriers cause firms to enter or leave the market in periods of supernormal or subnormal profit so firms make normal profit in the long-run.

Question 7

What happens in the long-run of firms in monopolistic competition markets?

Answer 7

The demand curve shifts leftward as firms enter the market.

Question 8

When is long-run profit maximisation achieved in monopolistic competition markets?

Answer 8

When AR = ATC.

Question 9

Where is long-run profit maximisation achieved on this graph?

Answer 9

At point B.

Question 10

What happens when AR touches the ATC curve?

Answer 10

All abnormal profit has been removed, and the firm has maximised long-run profit.

Question 11

What happens in monopolistic competition in terms of efficiency?

Answer 11

Firms are both productively and allocatively inefficient.
P > MC and the firm produces above the lowest point on its ATC curve.

Question 12

Why do monopolistically competitive firms not produce at the lowest point on their ATC curve?

Answer 12

There are no economies of scale to take advantage of.

Question 13

What does not producing at the lowest point on an ATC mean for monopolistically competitive firms?

Answer 13

This is productive inefficiency, and takes the form of excess capacity, measured by the difference between Q1 and Q2.

Question 14

What must monopolistically competitive firms do in the long-run to ensure normal profits are made?

Answer 14

Unnecessary costs must be eliminated, or normal profits will not be made.

Question 15

Why do monopolistic firms need to remove unnecessary costs in the long-run?

Answer 15

If they are not removed, subnormal profits will be made due to new firms entering the market in monopolistic competition.

Question 16

Why do some economists think monopolistic competition improves economic welfare?

Answer 16

The level of product differentiation outweighs the loss in productive efficiency seen in other market types. Consumers may value a wider choice above the increases in productive efficiency.

Question 17

What did Kelvin Lancaster claim monopolistic competition does?

Answer 17

The number of differentiated products increases until the gain for consumers in choice is equal to the loss of producing less existing goods at a higher cost.

Essentially, he argued that monopolistic competition does not lead to economic waste.

Question 18

How can advertising be divided?

Answer 18

Informative advertising
Persuasive advertising

Question 19

What is informative advertising?

Answer 19

Provides consumers with useful information about goods and services which are available to buy.

Question 20

What is persuasive advertising?

Answer 20

Attempts to make people think it’s a ‘must-have’ product. However, little information about the good itself is given.

Question 21

What often follows persuasive advertising?

Answer 21

Saturation advertising.

Question 22

Who uses saturation advertising and why?

Answer 22

Monopolies, because it prevents smaller firms from entering the market as they cannot afford the minimum level of advertising necessary for retailers to stock their products.

Question 23

Why is information advertising used?

Answer 23

It increases competition in a market.

Question 24

What is price competition?

Answer 24

A firm reducing prices in order to sell more of a good or service.

Question 25

How do increased sales occur?

Answer 25

Consumers switch from other markets where prices are higher and buy this good instead.
Consumers switch from buying similar goods in the same market to buy the cheaper substitute.

Question 26

Why do some argue that monopolies do not partake in price competition?

Answer 26

It is self-defeating, as monopolies produce 100% of market output so they would only help consumers.

Question 27

Why do monopolies partake in price competition?

Answer 27

Limit pricing and predatory pricing both exist to maintain a monopolies supernormal profit in the long-run.

Question 28

How and why do firms in monopolistic competitive markets or competitive oligopolies partake in price competition?

Answer 28

The most common form is special offer pricing.

Increases short-term sales which should theoretically increase revenue and therefore profit from the increased sales.

Question 29

How else can firms gain market share or protect existing sales other than price competition?

Answer 29

Non-price competition.

Question 30

What is non-price competition?

Answer 30

A producer attempts to increase sales by changing factors other than price.

Question 31

What can non-price competition include?

Answer 31

Marketing competition
Persuasive advertising
Quality competition

Question 32

What is marketing competition?

Answer 32

Claiming your good is superior through advertising campaigns.

Question 33

What is quality competition?

Answer 33

Giving benefits that competitors do not after purchasing the good.

Question 34

What can monopolistic competition be described as?

Answer 34

Imperfect competition among the many.

Question 35

What types of efficiency do firms in monopolistic competition exhibit?

Answer 35

Dynamic efficiency.