6.3. Monopolistic Competition without Trade Flashcards
Assumption one
Each firm produces a good that is similar to, but differentiated from, the goods that other firms in the industry produce.
As products are differentiated, a firm can raise its price without losing all its customers to other firms.
Each firm faces a downwards sloping demand curve and has some control over the price it charges.
Assumption two
There are many firms in the industry.
If the number of firms in the industry is N, then D/N represents the share of demand each firm faces when the firms are charging the same price.
When only one firm lowers its price, it will face a flatter demand curve, d.
Assumption three
Firms produce using a technology with increasing returns to scale.
Increasing returns to scale means that average costs fall as the quantity produced increases.
Whenever P>AC, the firm earns monopoly profits.
Assumption four
Firms can freely enter and exit the industry.
Firms will enter as long as it is possible to make monopoly profits.
The more firms that enter, the lower the profits per firm become.
Profits for each firm end up being zero in the long-run, as in perfect competition.
Short-run monopolistic competition with no trade
Very similar to a monopoly.
Each firm faces demand, d0, and produces Q0, at which MR=MC.
The resulting market price is P0.
The firm earns monopoly profits.
Long-run monopolistic competition with no trade
New firms continue to enter the market wherever they can earn monopoly profits.
In the long-run, the entry of new firms draws demand away from existing firms, causing the demand curve to shift left.
As the demand curve shifts left, the variety of products on the market increases and consumers become more price sensitive.
The new demand curve is more elastic (flatter), termed d1.
New firms continue to enter the industry until the price charged by the firm is on the average cost curve and monopoly profit is therefore zero.
At this point, PA=AC, this is the long-run equilibrium with no reason to change further.
