LS11- Monopolistic Competition

Question 1

Characteristics of monopolistic competition

Answer 1

• many buyers and sellers
• slightly differentiated goods, firms are price makers and there is price elastic demand
• low barriers to entry/exit (relatively low costs)
• good information
• non-price competition e.g. based on branding and quality
• firms are profit maximisers

Question 2

Why are goods only slightly differentiated in monopolistic competition?

Answer 2

Because there are very good substitutes available as there are lots of other firms.

Question 3

Examples of monopolistically competitive markets

Answer 3

• clothing markets
• taxis
• fast food restaurants
• hairdressers

Question 4

SR diagram of monopolistic competition

Answer 4

• just the monopoly diagram
• AR=D, MR is twice as steep
• AC curve, MC cuts AC at its lowest point
• firms are profit maximisers so produce at MR=MC
• AR>AC so firms are making supernormal profit in the short run

Question 5

LR diagram of monopolistic competition - why does it take that form?

Answer 5

• supernormal profits do not last as new firms enter the market because of the low barriers to entry and good information
• as new firms enter the market, demand for individual firms in the market will shift to the left until AR=AC i.e. until normal profit is made

Question 6

Evaluation of monopolistic competition in LR

Answer 6

• P is greater than MC so allocative efficiency (P=MC) is not achieved therefore consumers are exploited, prices>costs, output & choice is restricted
• not on min point of AC curve so productive efficiency is not achieved therefore voluntarily foregoing EoS
• dynamic efficiency not achieved because there is no LR supernormal profit to be reinvested

Question 7

Counter the evaluation of monopolistic competition for allocative efficiency

Answer 7

• compared to a monopoly, loss of allocative efficiency is nowhere near as bad due to high price making ability therefore much less loss of consumer surplus
• compared to perfect competition where there are homogenous goods, there are goods tailored to consumer wants therefore consumers are more willing to pay more

Question 8

Counter the evaluation of monopolistic competition for productive efficiency

Answer 8

• compared to a monopoly, it is nowhere near as bad since there are good substitutes so firms can’t afford to forego economies of scale to the same extent as monopolies
• in perfect competition, there may not be many EoS at all so prices may actually be lower than in perfect competition where there are some EoS
• productive inefficiency in monopolistic competition may be due to the product differentiation demands of consumers which might make it more difficult to bulk buy and achieve EoS

Question 9

Counter the evaluation of monopolistic competition for dynamic efficiency

Answer 9

• we could argue there is dynamic efficiency in monopolistic competition if SR supernormal profits are enough to reinvest
• in a very competitive market, we can still get dynamic efficiency if normal profits are being reinvested for survival
• many arguments to say dynamic efficiency does not occur in a monopoly