Monopolistic Competition

Question 1

What is monopolistic competition?

Answer 1

Firms are price makers
But there are competing firms and firms can enter and exit

Question 2

What are the assumptions of monopolistic competition?

Answer 2

Sellers are price makers
Buyers are price takers
Free entry and exit in long run

Question 3

Assumption that sellers have market power is more likely if one or more of the following hold…

Answer 3

• firms produce heterogenous products
  but still similar enough to be affected by actions of other firms (pubs, corner shops, magazines)
• few firms in the market
• imperfect information and transaction costs maybe present

Question 4

Difference in SR & LR for a monopolistic competition?

Answer 4

SR / firms behave like monopolists
LR / entry shifts demand curve inwards til economic profits are 0

Question 5

Draw me a SR monopolistic market equilibrium

Answer 5

Question 6

Draw me a LR Monopolstic market equilibrium

Answer 6

Question 7

In monopolistic competition, why do firms make 0 economic profits in the LR?

Answer 7

Due to free entry and exit

Question 8

Why do firms produce where AC > Min AC

Answer 8

• as MR = MC to left of minAC : often called the excess capacity problem
• excess capacity problem ignores fact that consumers seem to value variety

Question 9

Why do lower fixed costs lead to more firms in LR equilibrium

Answer 9

Lower fixed costs in monopolistic competition lead to more firms in the long-run equilibrium because reduced fixed costs make it easier for new firms to enter the market. With lower entry barriers, more businesses can afford to join, increasing the overall number of firms in the market.