Monopolistic Competition Flashcards
Differentiated Products
Products sold within a given market that are not regarded as identical by consumers.
Monopolistic Competition
- A large number of small firms (low concentration).
- Each firm produces a product that is distinguished from those produced by rival firms (differentiated products).
- A firm can raise the price of its product without losing all of its customers (price maker). However, firms are in competition with one and other for customers.
- Low barriers to entry tend leave incumbent firms vulnerable to competitors entering the market in the long-run.
Profit Maximisation
MR = MC
Profit in the Short-Run
Firms cannot avoid their sunk costs in the short-run and therefore if the loss minimising price lies between average total and average variable costs firms produce to minimise their losses.
A firm in a monopolistically competitive market will shut down if average variable cost exceeds its loss minimising price.
Efficiency in the Short-Run
As is the case in monopoly, a monopolistically competitive firm never produces the allocatively efficient quantity.
A firm in a monopolistically competitive market will not typically achieve productive efficiency in the short-run.
Long-Run Equilibrium
Low barriers to entry mean that firms can freely enter or exit a monopolistically competitive market in the long-run.
As in perfect competition firms, enter markets when there is a possibility of earning economic profits and exit markets to avoid economic losses.
The result is that firms earn zero economic profit in the long-run, although the mechanism is different to the mechanism that operates in perfect competition.
Entry and Exit
- Each firm introduces a new product.
- Entry involves “Business Stealing”.
- Each firm then experiences a drop in demand.
Productive Efficiency in the Long-Run
Productive efficiency is never achieved in the long-run.
