Schedule H - Monopolistic Competition Flashcards
What is monopolistic competition?
Monopolistic competition is a form of imperfect competition where a large number of producers sell products that are differentiated from each other by branding or quality for example. Barriers to entry and exit are low.
Give 5 examples of monopolistically competitive markets
Coffee stores, pizza delivery businesses, hairdressers, fast food takeaways, plumbers,
What are the main characteristics of monopolistically competitive markets?
- A large number (many) buyers and sellers
- Slightly Differentiated products
- Low barriers to entry and exit
- Good information
- Little price-making ability
- Non-price competition
- Firms are profit maximisers
The monopolistically competitive market has the same diagram with a small difference. What is the difference?
The demand curves are slightly more elastic than monopoly. This is hard to show so we might note it in our writing instead.
Why do supernormal profits not last in the long run for monopolistically competitive market?
In the long run:
- Supernormal profit in the short-run will therefore attract new suppliers offering new products and therefore only normal profits can be made in the long run, i.e. where AR=AC
- As more firms enter the market, the demand curve for an existing firm SHIFTS TO THE LEFT as some consumers opt to buy products offered by new or alternative companies.
- The demand curve therefore moves left until it is tangential to the AC curve
- The MR curve will also shift inwards with the AR curve
- At this point, the monopolistically competitive firm is at its profit-maximising level of output (because MR=MC) but it is also only making normal profit (AR=AC)
How do we draw the long run equilibrium for a monopolistically competitive market?
- Draw the AR (demand) curve
- Draw on the AC curve so that the AR curve is tangential to the AC curve
- From the point where the AC touches the AR, draw a dotted line to the x axis and y axis
- Add on the marginal cost curve, cutting the AC curve at its lowest point
- Draw on the MR curve and ensure it cuts MC where the dotted line is.
Is the Monopolistically Competitive market allocatively efficient? Explain your answer.
It is NOT allocatively efficient. Prices are above marginal cost; in other words AR is not equal to MC - price is not equal to supply.
Is the cross price elasticity of a monopolistically competitive market high or low?
It is high. They are slightly differentiated but not that much. They are many substitutes so the XED is high.
Is the Monopolistically Competitive market productively efficient? Explain your answer.
No it is NOT productively efficient. Saturation of the market may lead to businesses being unable to exploit fully internal economies of scale - causing long-run average costs to be higher and therefore not productively efficient.
Is the Monopolistically Competitive market dynamically efficient? Explain your answer.
Not in the long run. In the long run, there aren’t any supernormal profits so there won’t be funds available for research and innovation
Assess the extent to which monopolistic competition leads to economic efficiency. - what would be the Knowledge, Application and Analysis point for this?
In monopolistic competition, we might assume that there are many firms selling slightly differentiated products and the barriers to entry are low. An example might be many sandwich shops competitive in a city centre.
Intense competition between suppliers means that demand is likely to be price elastic which then means that prices may move closer to marginal cost. Therefore, in contrast to a monopoly, prices for consumers will be lower and this would be an improvement in allocative efficiency of scarce resources.
Assess the extent to which monopolistic competition leads to economic efficiency. How can we evaluate the points that prices move closer to marginal cost and so lower prices give an improvement in AE.
However, firms in monopolistic competition still have pricing power since AR and MR are downward sloping. This is especially true for firms with strong brand loyalty. Even if the entry of new firms and products means that normal profits are made in the long run, price will remain above marginal cost so allocative efficiency is not achieved. The saturation of many differentiated products in monopolistic competition may also lead to productive efficiency as firms are unable to fully exploits economies of scale in the long run.
