4.1.5.4 Monopolistic competition Flashcards
What are the key characteristics of monopolistic competition?
Many buyers/sellers, product differentiation, no barriers to entry/exit, some price-setting power, imperfect information, non-price competition.
How does product differentiation affect demand?
Creates downward-sloping demand curve - firms can raise prices without losing all customers (but makes XED high with close substitutes).
What is the profit maximization condition?
MC = MR (same as perfect competition) - shown where the marginal cost curve intersects marginal revenue.
What happens in the short run?
Firms can earn supernormal profits (area between price and AC at profit-maximizing output).
Why do profits disappear in the long run?
New entrants attracted by profits → increased competition → demand becomes more elastic (AR curve shifts left) until only normal profits remain.
How do firms try to maintain short-run profits?
Through product differentiation and innovation to maintain brand loyalty.
What is non-price competition?
Competing through factors other than price: branding, quality, advertising, product features.
Why is there excess capacity?
Firms don’t produce at minimum AC (not productively efficient) → have unused production potential.
What are examples of monopolistic competition?
Hairdressers, restaurants, plumbers - differentiated but with many substitutes.
How does allocative efficiency compare to perfect competition?
P > MC in both short and long run → allocatively inefficient (unlike perfect competition where P=MC).
Why might dynamic efficiency be limited?
Long-run normal profits provide less funds for R&D than monopoly supernormal profits.
What is x-inefficiency?
Lack of incentive to minimize costs due to weak competitive pressure → operates above lowest possible cost curve.
What are advantages for consumers?
Product variety, innovation from differentiation, some price competition.
Why is this model more realistic than perfect competition?
Incorporates real-world factors like product differentiation and imperfect information.
How does entry/exit differ from perfect competition?
Similar free entry/exit, but in monopolistic competition new entrants must differentiate their product.
What happens to the demand curve in long run?
Becomes more elastic and shifts left as substitutes enter market.
Where is long-run equilibrium?
Where AR = AC (normal profits) but P > MC (allocative inefficiency) and not at minimum AC (productive inefficiency).
How does market power compare to monopoly?
Much weaker - many close substitutes limit price-setting ability.
What is the role of advertising?
Key non-price competition method to differentiate products and build brand loyalty.
Why are firms productively inefficient?
Don’t produce at lowest point on AC curve (excess capacity) due to differentiated demand.
How does consumer choice compare to perfect competition?
Greater variety due to product differentiation, though higher prices.
What happens if a firm improves quality?
Temporary competitive advantage until rivals imitate → typical of dynamic competition in this market.
Why is this considered ‘monopolistic’?
Each firm has limited monopoly power over its particular differentiated product.
How does welfare compare to perfect competition?
Lower overall due to inefficiencies, but offset by benefits of product variety and innovation.
