Monopolistic Competition

Question 1

Define monopolistic competition

Answer 1

Market with many small firms that supply 🚘 which vary slightly allowing some price-setting powers

Question 2

What are the similarities between perfect competition and monopolistic competition?

Answer 2

NOTE- like perfect competition firms, monopolistic competition firms ALSO ✖️ make supernormal profits in long run due to almost perfect knowledge where rival firms know when firms making supernormal profits and … enter industry (due to ⬇️ barriers to entry) and compete away supernormal profits

ALSO- like perfect competition firms, monopolistic competition firms ALSO ✖️ make losses in long run due to very ⬇️ barriers to exit- … firms making losses easily leave industry rather than persevering in long run- ✖️ have enough cash reserves to continue with short term loss for incentive of long-run profits

Question 3

What are the differences between perfect competition and monopolistic competition?

Answer 3

1) Small price setting powers (produce 🚘 that varies slightly … consumers have some loyalty to particular 🚘 from particular firm)
2) Demand curve ✖️ perfectly elastic
3) Firm under monopolistic competition ✖️ need to operate at productively (lowest point on average cost curve) and allocatively (welfare maxed- P=MC) efficient points of output

Question 4

What are examples of industries under monopolistic competition?

Answer 4

Restaurants, Hairdressers etc

Question 5

What are the characteristics of firms under monopolistic competition?

Answer 5

Number of firms- many small firms
Type of product- similar BUT ✖️ homogenous- difference in quality, branding, advertising etc
Knowledge- imperfect about rival firms pricing and output strategies BUT know when rival firm making supernormal profits
Barriers to entry/exit- ⬇️
Price setting powers- limited price setting powers- 🚘 slightly different

Question 6

Describe the diagram which shows firms in monopolistic competition making supernormal profits (NOTE ONLY IN SHORT ✖️ IN LONG RUN)

Answer 6

SAME AS MONOPOLY MAKING SUPERNORMAL PROFITS:
Draw MC, AC, MR, AR curves normally (with AC starting above MC but after intersection goes under)
Firm producers at profit maximising equilibrium (MC=MR)
At point where MC=MR- quantity vertically ⬇️ AND price found by moving ⬆️ vertically to AR (demand) curve and then moving horizontally ⬅️
From that point on AR move vertically ⬇️ until AC curve and then move horizontally ⬅️ to create box of supernormal profits (profits above costs)
Y-axis = revenue/costs
X-axis = quantity
SEE BOTTOM OF PAGE 29 THEME 3 BOOK

Question 7

Describe the diagram which shows the LONG RUN position of firms in monopolistic competition

Answer 7

Draw MC, AC, MR, AR curves normally (with AC starting above MC but after intersection goes under BUT WITH THE AC CURVE AS A TANGENT TO THE AR CURVE)
Firm produces at profit maximising equilibrium (MC=MR) in long run
At point where MC=MR- quantity vertically ⬇️ AND price found by moving ⬆️ vertically to AR (demand WHERE AC IS ALSO TOUCHING AR CURVE- TANGENT) curve and then moving horizontally ⬅️
Y-axis = revenue/costs
X-axis = quantity
… firms make normal profits in long run as make supernormal profits and losses ONLY in short run
SEE TOP OF PAGE 30 THEME 3 BOOK