Monopolistic Competition

Market Structure
Perfect competition, with an infinite
number of firms, and monopoly, with a
single firm, are polar opposites
Monopolistic competition and oligopoly lie
between these two extremes.
Monopolistic competition is a market
structure in which there are many firms
selling differentiated products
There is no incentive for firms to cooperate
in ways that reduce competition

Characteristics of Monopolistic
Competition
1. Many sellers each satisfying a small but not microscopic
share of market
2. Product differentiation where the goods that are sold
arent homogenous
3. Ease of entry of new firms in the long run because
there are no significant barriers to entry
Firms compete by selling differentiated products that are
highly substitutable for one another but not perfect
substitutes. The cross-price elasticities of demand are large
but not infinite.
16-3

Features
A blend of competition and monopoly
Competitive element: many sellers; firms
can enter the industry quite freely in long
run
Difference: sells differentiated products

Monopoly element: due to differentiated

product, each firm enjoys some market
power
Difference: Market power is limited by existence
of close substitutes
entry is rather easy

Differentiated Product
Similar, but not identical
Toothpaste, detergents etc.
Differentiation can be real (breakfast
cereals)
Differentiation can be non-real
(aspirin)
Rivalry among firms take place in
forms of:
Product quality
Services

Monopolistic Competitor
Chamberlin called the sellers of
differentiated products as product group
We cannot derive industry supply and
demand curves as we do not have a
single price, but a cluster of prices
By demand facing the firm, we mean the
market share of the firm

Output, Price, and Profit of a

Monopolistic Competitor
Like a monopoly
The monopolistic competitive firm has some
monopoly power so the firm faces a downward
sloping demand curve
Marginal revenue is below price
At profit maximizing output, marginal cost will be
less than price
Like a perfect competitor,
zero economic profits exist in the long run
16-7

Short Run Equilibrium

It is just the
same as the
Monopolists
short run
equilibrium
The firm may
just break
even, or may
have profits or
losses
If it has losses,
it tries to
minimise loss.
P= AVCmin is
the shutdown
point

Long Run Equilibrium

D1
D2

LMC

LAC

P*

D1

D2

MR
q*

MR = LMC as well as P = LAC to ensure there is no profit no loss

Sustainability Strategy
Product variation
Advertising
To make the product more price inelastic

Problem

Your city has a single bookstore which

sells books at a price of Rs. 20 and
average cost of Rs. 11. Suppose the
city eliminates restrictions and new
stores enter. Each additional book
store decreases the price of book by
Rs. 2 and increases the average cost
by Re 1. Predict the equilibrium
number of book stores.