5.4 Monopolistic Competition

Question 1

What are the characteristics of monopolistically competitive markets?

Acronym- I Stopped No Lads Competing Next Semester

Answer 1

• Imperfect competition.
• Short run profit maximisers.
• Non-homogeneous products due to branding.
  (-however, a lot of relatively close substitutes. This makes the XED of goods and services sold high)
• Large number of buyers and sellers, which are relatively small and act independently.
  (-each seller has the same degree of market power as other sellers, but their market power is relatively weak).
• Compete using non-price competition.
• No barriers to entry to and exit from the market.
• Since firms have a downward sloping demand curve, they can raise their price without losing all of their customers. (this is because firms have some degree of price setting power).

Question 2

Give some examples of monopolistic competition

Answer 2

• hairdressers and regional plumbers.

Question 3

Profit maximising equilibrium in the short run

Answer 3

• In the short run, firms profit maximise at the point MC = MR.
• make supernormal profits
• Firms can try and stay in the short run by differentiating their products and
  innovating.

Question 4

Draw a diagram to illustrate the profit maximising equilibrium in the short run
Explain the diagram

Answer 4

• The area P1C1AB represents the supernormal profits that firms in a monopolistically competitive market earn in the short run.

Question 5

Profit maximising equilibrium in the long run

Answer 5

• In the long run, new firms enter the market since they are attracted by the profits that existing firms are making.
• This makes the demand for the existing firms products more price elastic which shifts the AR curve (the demand curve) to the left.
• Consequently, only normal profits can be made in the long run. The long run equilibrium point is P1Q1.

Question 6

Draw a diagram to illustrate the profit maximising equilibrium in the long run
Explain the diagram

Question 7

What are the advantages of a monopolistically competitive market?

Answer 7

• Consumers get a wide variety of choice.
• The model of monopolistic competition is more realistic than perfect competition.
• The supernormal profits produced in the short run might increase dynamic efficiency through investment.

Question 8

What are the disadvantages of monopolistically competitive market?

Answer 8

• Firms are allocatively inefficient in the short and long run (P > MC)
• Since firms do not fully exploit their factors, there is excess capacity in the market-this makes firms productively inefficient
• The firm does not operate at the bottom of the AC curve so theres productive inefficiency.
  -This is in both the short run and long run.
• In the long run, dynamic efficiency might be limited due to the lack of supernormal profits.
• Firms are not as efficient as those in a perfectly competitive market.
• In a monopolistically competitive market, firms have x-inefficiency, since they have little incentive to minimise their costs.