Monopolistic competitionThe model of monopolistic competition describes a common market structure in which firms have many competitors, but each one sells a slightly different product. Show
Many small businesses operate under conditions of monopolistic competition, including independently owned and operated high-street stores and restaurants. In the case of restaurants, each one offers something different and possesses an element of uniqueness, but all are essentially competing for the same customers. CharacteristicsMonopolistically competitive markets exhibit the following characteristics:
Equilibrium under monopolistic competitionIn the short run supernormal profits are possible, but in the long run new firms are attracted into the industry, because of low barriers to entry, good knowledge and an opportunity to differentiate. Monopolistic competition in the short runAt profit maximisation, MC = MR, and output is Q and price P. Given that price (AR) is above ATC at Q, supernormal profits are possible (area PABC). As new firms enter the market, demand for the existing firm’s products becomes more elastic and the demand curve shifts to the left, driving down price. Eventually, all super-normal profits are eroded away. Monopolistic competition in the long runSuper-normal profits attract in new entrants, which shifts the demand curve for existing firm to the left. New entrants continue until only normal profit is available. At this point, firms have reached their long run equilibrium. Clearly, the firm benefits most when it is in its short run and will try to stay in the short run by innovating, and further product differentiation. Examples of monopolistic competitionExamples of monopolistic competition can be found in every high street. Monopolistically competitive firms are most common in industries where differentiation is possible, such as:
The survival of small firmsThe existence of monopolistic competition partly explains the survival of small firms in modern economies. The majority of small firms in the real world operate in markets that could be said to be monopolistically competitive. EvaluationThe advantages of monopolistic competitionMonopolistic competition can bring the following advantages:
The disadvantages of monopolistic competitionThere are several potential disadvantages associated with monopolistic competition, including:
InefficiencyThe firm is allocatively and productively inefficient in both the long and short run. There is a tendency for excess capacity because firms can never fully exploit their fixed factors because mass production is difficult. This means they are productively inefficient in both the long and short run. However, this is may be outweighed by the advantages of diversity and choice. As an economic model of competition, monopolistic competition is more realistic than perfect competition – many familiar and commonplace markets have many of the characteristics of this model. Test your knowledge with a quizPress Next to launch the quizYou are allowed two attempts – feedback is provided aftereach question is attempted. What happens when new firms enter a monopolistically competitive market?Monopolistic competition in the short run
As new firms enter the market, demand for the existing firm's products becomes more elastic and the demand curve shifts to the left, driving down price. Eventually, all super-normal profits are eroded away.
What happens in a monopolistically competitive market when new firms enter the market quizlet?-in monopolistic competition, the end result of entry and exit is that firms end up with a price that lies on the downward-sloping portion of the average cost curve, not at the very bottom of the AC curve. Thus, monopolistic competition will not be productively efficient.
What happens when new firms enter a perfectly competitive market?When new firms enter a perfectly competitive market, the numbers of suppliers in the industry rise, the market quantity supplied at each level of prices will increase. This will shift the market supply curve to the right. Because the market demand curve does not change, the market price will fall.
What happens when a firm enters a monopoly market?A monopolistic market is the opposite of a perfectly competitive market, in which an infinite number of firms operate. In a purely monopolistic model, the monopoly firm can restrict output, raise prices, and enjoy super-normal profits in the long run.
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