Overview
This lecture explains the key features of monopolistic competition, compares it to perfect competition and monopoly, and discusses related market characteristics and outcomes.
Monopolistic Competition vs. Monopoly
- Monopoly: one firm sells a unique product with no close substitutes.
- Monopolistic competition: many buyers and sellers offer differentiated (heterogeneous) products.
- Small change in terminology (“monopolistic” vs. “monopoly”) signals major structural differences.
- Monopolistic competition is considered a hybrid of perfect competition and monopoly.
Characteristics of Monopolistic Competition
- Many firms exist, each selling differentiated products (e.g., McDonald's vs. KFC).
- Products are not identical; each firm’s product has unique qualities.
- Market entry is easy—firms can join by creating their own distinct products.
- Firms have some, but limited, control over prices due to product differentiation.
- Information is often incomplete; firms do not fully reveal product details.
- Collusion is nearly impossible because of the large number of firms.
- Non-price competition (e.g., advertising, branding) is common.
- Demand curve is downward sloping and elastic for individual firms.
Economic Outcomes in Monopolistic Competition
- Firms may earn economic profit in the short run if price exceeds average cost (AR > AC).
- In the long run, entry of new firms shifts the demand curve, making long-term economic profit unlikely—firms earn normal profit.
- Productive and allocative efficiency can be achieved to some extent, but not fully.
- Economic profit is represented by the area where price exceeds average cost.
Graphical Analysis
- Profit maximization occurs where marginal cost (MC) equals marginal revenue (MR).
- The gap between price (AR) and average cost (AC) at the profit-maximizing output shows economic profit.
- In the long run, new entry shifts the demand curve, reducing profits to normal levels.
Key Terms & Definitions
- Monopoly — market with one firm selling a unique product.
- Monopolistic Competition — market with many firms selling differentiated products.
- Heterogeneous Product — products that are different from each other in significant ways.
- Non-Price Competition — competition through means other than price (e.g., advertising).
- Economic Profit — occurs when a firm's total revenue exceeds total costs, including opportunity costs.
- Normal Profit — when a firm's total revenue equals total costs, resulting in zero economic profit.
- Elastic Demand — when the quantity demanded changes significantly with price changes.
Action Items / Next Steps
- Review the graphical analysis of economic profit and long-run adjustments for monopolistic competition.
- Prepare for the next lesson on economic loss and disadvantages of monopolistic competition.