Market Structure: Combines elements of competitive markets and monopoly.
Buyers and Sellers: Many in the market, similar to competitive markets.
Product Differentiation: Goods are slightly differentiated, allowing firms to set their own prices, but only slightly due to the availability of good substitutes.
Price Elasticity: Firms face price elastic demand curves.
Barriers to Entry/Exit: Low barriers, enabling easy entry and exit for firms.
Market Information: Good information on market conditions is available.
Non-Price Competition: Focus on branding, advertising, quality of product/service as firms cannot raise prices substantially.
Profit Maximization: Firms produce where marginal cost (MC) equals marginal revenue (MR).
Examples
Clothing markets
Taxis
Fast food restaurants
Hairdressers and salons
Bars and nightclubs
Firm Behavior
Short Run
Diagram: Similar to monopoly.
Revenue Curves: Downward sloping, AR (average revenue) and MR (marginal revenue).
Cost Curves: Average cost (AC) and MC intersecting at AC's lowest point.
Profit Maximization: Where MR equals MC gives quantity (Q1) and price (P1).
Supernormal Profit: Possible due to price-making power.
Long Run
Market Entry: New firms enter, attracted by supernormal profits.
Demand Shift: Demand for individual firms shifts left as more firms enter, reducing supernormal profits to normal profits where AR = AC.
Diagram Process: AR and MR curves drawn, MC is added, followed by profit-maximizing price and quantity, finally ensuring AC touches AR for normal profit.
Evaluation of Market Structure
Efficiency
Allocative Efficiency: Not achieved as price (P1) is greater than MC in the long run.
Productive Efficiency: Not achieved as firms do not operate at the minimum average cost.
Dynamic Efficiency: Generally not present due to lack of long-term supernormal profit.
Comparison with Other Structures
Perfect Competition: Achieves allocative and productive efficiency but not dynamic.
Monopoly: Fails in allocative and productive efficiency but may achieve dynamic efficiency.
Monopolistic Competition: Appears inefficient but might be preferable due to product differentiation and competitive pressures.
Evaluation Points
Allocative Inefficiency: While present, it is less severe than in monopoly due to competition.
Consumer Preferences: Differentiation may justify a slight loss in consumer surplus.
Economies of Scale: Productive inefficiency may result from the need to differentiate products.
Dynamic Efficiency: Possible if short-run profits are reinvested or due to competitive pressures to innovate.
Conclusion
Despite theoretical inefficiencies, monopolistic competition may offer advantages like variety and innovation, making it potentially the best market structure in reality.