Monopolistic competition

(1) There is a large number of buyers and sellers

(2) Few barriers to entry into the market. Also it is easy for firms to recoup their
expenditure on exit from the market.
(3) Consumers face a wide choice of differentiated products. Each firm has a slight
degree of monopoly power in that it controls its own brand.
(4) Monopolistic firms have some influence on the market price and are therefore price
makers.
(5) Each firm aims to maximize profits.

Examples

Hair dressing salons, bakeries, travel agencies and restaurants.

The demand curve

The demand curve facing the individual firm will be downward sloping but relatively
elastic because of the presence of substitutes.

The conduct of firms

Pricing policy-the firm is a price maker. A successful firm might take advantage of a
greater market share and brand loyalty and so charge a higher price. It would
increase sales revenue by doing this in the portion of the demand curve where the
demand for the firms product is inelastic. If demand for the firms product is elastic
the firm should reduce price to increase revenue.

Non price competition-strategies other than a price cut adopted by producers to

give their product a competitive advantage. The firms usually practice product
differentiation and advertising and promotions.

Product differentiation is a set of marketing strategies designed to capture and to retain

particular market segments by producing a range of related products. These produces may be
differentiated in terms of packaging, design and advertising. The firm can invest in creating a
strong brand image. Through successful advertising the firm can increase demand for its product
and reduce the price elasticity (make more inelastic) of demand for the product. Advertising can
make consumers feel that there are no close substitutes to the firms products. Since all firms
would advertise some argue that the advantage gained from advertisements is only temporary
and it adds to the firms cost. The firm can use a combination of marketing and product
innovations. They can try to improve the packaging of a product and so forth.
Performance of firms Monoplistic Competition

Output-Output is below the optimum level {excess capacity}. The price change
would be higher than what they would charge if output was higher.

Barriers to entry-There are few barriers to entry such as advertising and brand
names.

Profits- Firms can make abnormal profits in the short run but rivals are free to enter
the market.

Fig 1:Short run equilibrium in the monopolistic market.

TC=OCBQ1
TR=OP1AQ1
There are abnormal profits of CP1AB

In the long run the firm would make normal profits.

Fig 2: Long run equilibrium in monopolistic competition.

L3: Long run equilibrium in monopolistic competition

TR=PQ

TR=OPBQ1

TC=AC Q=OCOQ1

TC=OCBQ1

Economic Efficiency

In the short run there is no allocative efficiency because price does not equal
marginal cost. This does not happen in the long run either.

In the short run there is no productive efficiency because the firm is not producing
at the lowest point on the average cost curves. This does not happen in the long run
either.