Reference

http://www.dineshbakshi.com/as-a-level-economics/price-system-theory-of-firm/119-revision-
notes/1777-monopolistic-competition Page 1

Monopolistic Competition

It is a market with many competing firms where each firm has a little bit of market
share. Firms have the ability to set their own prices.
Assumptions
Many, many firms produce in a monopolistically competitive industry.
Each firm produces a product that is differentiated (i.e., different in character) from all
other products produced by the other firms in the industry.
There is free entry and exit of firms in response to profits in the industry.
Consumer and producer have imperfect knowledge of the market.
Examples, car mechanics, salons, plumbers and jewelers.
Toothpastes and toilet papers are examples of differentiated products.
Revenue Curves
In a monopolistic competition, a firm will face a downward sloping demand curve. The
MR curve lies just below the demand curve.






Reference
http://www.dineshbakshi.com/as-a-level-economics/price-system-theory-of-firm/119-revision-
notes/1777-monopolistic-competition Page 2

The demand curve is more elastic and flatter than monopoly demand curve. The
reason being that though firms are price makers to a certain extent, their demand is still
relatively elastic since there are many, slightly different, substitutes.
The firm produces at profit maximising level i.e. MC=MR.
The firm will produce an output q and sell that output at the price P.
Short run Profit & Loss
In the short run a monopolistically competitive firm will produce at the profit maximising
level MC=MR where the AC is below the AR curve. If the firms AC is above the AR
curve, the firm will experience losses.

Long run Normal Profit
In the long run a monopolistic competitive firm will have normal profit.
Reference
http://www.dineshbakshi.com/as-a-level-economics/price-system-theory-of-firm/119-revision-
notes/1777-monopolistic-competition Page 3


REASON
There is freedom to entry and exit; Due to this , when firms make abnormal
profits in the short run, it will attract more firms in the industry, the supply
will increase, prices will come down and firms prices will come it will return
to long run normal profit. Similarly, if firms are making losses, they will exit
the industry, this will lead to fall in supply, leading to rise in prices, leading
to normal profit for firms.

Non Price Competition
Non-price competition is where "one firm tries to distinguish its product or
service from competing products on the basis of attributes like design and
workmanship"
Non-price competition typically involves
Promotional expenditures such as advertising, selling staff, the
locations convenience, sales promotions, coupons, special orders, or free
gifts
Marketing research,
New product development,
Reference
http://www.dineshbakshi.com/as-a-level-economics/price-system-theory-of-firm/119-revision-
notes/1777-monopolistic-competition Page 4

Brand management costs.
Productive and allocative efficiency in Monopolistic Competition

Short Run
In the Short Run a monopolistically competitive firm will neither achieve
allocative efficiency nor productive efficiency. As the diagram show,
productive efficiency is at q1 and allocative efficiency level of output is q2.
However, in a monopolistically competitive market, a firm is producing at
profit maximizing level q does not achieve any of the efficiency.








Long Run
In the long run too, a monopolistic competitive firm will not achieve any of the
efficiencies. In the diagram below, the firm is producing at the profit maximizing level of
q, does not achieve allocative efficiency level of output q2, or productively efficient level
of output q1.
Reference
http://www.dineshbakshi.com/as-a-level-economics/price-system-theory-of-firm/119-revision-
notes/1777-monopolistic-competition Page 5



Comparison between Perfect Competition
and Monopolistic Competition
Perfect Competition Monopolistic competition
Number of firms Infinite Many
Market power None Low
Elasticity of demand Perfectly elastic Highly elastic (long run)
Product differentiation None High
Excess profits No Yes/No (Short/Long)
Productive Efficiency Yes No
Allocative Efficiency Yes No
Profit maximization condition P=MR=MC MR=MC
Pricing power Price taker Price setter