Monopolistic Competition Flashcards
1
Q
Characteristics of Monopolistically Competitive Markets
A
- Has imperfect competition
- Firms are SR profit maximisers
- Firms sell non-homogeneous products (product differentiation). However, there are relatively close substitutes
- This makes XED of G&S sold high
- Model based on the assumption that there are large number of buyers & sellers, which are & relatively small & act independently
- Each seller has same degree of market power, but market power is relatively weak
- Firms compete using non-price competition
- No barriers to entry to & exit
- Since firms have a downward sloping demand curve, can raise price w/o losing all of their customers
- This is because firms have some degree of price setting power
- Buyers & sellers have imperfect
information - Examples of monopolistic competition include hairdressers & regional plumbers
2
Q
Profit Maximising Equilibrium in SR
A
- In SR, firms profit maximise at the point MC = MR
- Area P1C1AB represents supernormal profits that firms in a monopolistically competitive
market earn in the SR
3
Q
Profit Maximising Equilibrium in LR
A
- In LR, new firms enter the market since they are attracted by profits
- This makes the demand for the existing firms’
products more price elastic, shifting AR (demand) to the left - Consequently, only normal profits made in LR - LR equilibrium point is P1Q1.
- Firms can try & stay in SR by differentiating products & innovating.
4
Q
Adv. & Disadv. of Monopolistically Competitive Markets
A
Advantages:
- Allocatively inefficient in SR & LR (P > MC)
- Productively inefficient in SR & LR
- Consumers get wide variety of choice
- More realistic than perfect competition
- Supernormal profits produced in SR increases dynamic efficiency through investment
Disadvantages:
- In LR, dynamic efficiency limited due to lack of supernormal profits
- Firms not as efficient as those in perfectly competitive market
- Firms have x-inefficiency, little incentive to minimise their costs
