Microeconomics - Monopolistic Competition

Question 1

Characteristics of monopolistically competitive markets:

Answer 1

A monopolistically competitive market has imperfect competition. Firms are short run profit maximisers.

Firms sell non-homogeneous products due to branding (there is product differentiation). However, there are a lot of relatively close substitutes. This makes the XED of the goods and services sold high.

The model is based on the assumption that there are a 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.

Firms in a monopolistically competitive market compete using non-price competition.

There are 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.

Buyers and sellers in a monopolistically competitive market have imperfect information.

Examples of monopolistic competition include hairdressers and regional plumbers.

Question 2

Profit maximising in SR

Answer 2

In the short run, firms profit maximise at the point MC = MR.

Question 3

Draw a monopolistically competitive diagram in the sr

Answer 3

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Question 4

Draw a monopolistically competitive market in lr

Answer 4

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Question 5

Advantages of monopolistically competitive markets

Answer 5

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 (also note: the firm does
not operate at the bottom of the AC
curve). This is in both the short run
and long run.

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 6

Disadvantages of monopolistically competitive markets

Answer 6

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.