Monopolistic competition

Question 1

What are monopolistically competitive markets?

Answer 1

They are less contestable than perfectly competitive markets.

Characteristics:
- Large number of firms
- Differentiated products (different to perfect competition where products are identical)
- Low barriers to entry and exit
- Firms are price makers (different to perfect competition where firms are price takers)

Question 2

What happens to monopolistically competitive firms in the short run and in the long run?

Answer 2

In the short run, these firms can make SNP’s. This is due to the fact that there is differentiated products so demand for the product will be strong, however then, other firms will see that there are SNP’s available in the industry, and due to the lac of barriers to entry, other firms will then enter the industry, and this reduces demand for incumbent firms, and now there are normal profits being achieved in the long run.

Question 3

How efficient are monopolistically competitive firms?

Answer 3

• They are allocatively inefficient both in the short run and in the long-run however they have improved allocatively in the long - run because as demand falls, firm reduce prices, making them more allocatively efficient.
• They are not productively efficient in the short run or in the long run as AC does not equal MC.
• They can be dynamically efficient in the short run because they are making SNP’s, however they are unlikely to invest these profits into R&D due to low barriers to entry and so the firms can easily be copied. They are not dynamically efficient in the long run because they are not making profits to invest into R&D
• They are not X-inefficient in the long run or short run because they always have an incentive to reduce AC due to there being competition.

Question 4

Examples of monopolistically competitive firms?

Answer 4

• Restaurants
• Cafes
• Clothing shops (Zara)
• Spas
• Fats food chains (McDonalds)