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๐Ÿ’ธย  Unit 1: Basic Economic Concepts

4.4 Monopolistic Competition

#unit4

#competition

#monopoly

#marketstructures

#graphs

โฑ๏ธย ย 3 min read

written by

jeanne stansak

Caroline Koffke

caroline koffke

(editor)

November 15, 2020


Monopolistic competition is an imperfect market structure where many, various sized firms compete for market demand shares. This type of market structure has some characteristics that are the same or similar to perfect competition, as well as some characteristics that are the same or similar to monopolies. Some examples of monopolistic competition include restaurants, clothing companies, jewelers, hair salons, and furniture stores.

Characteristics of Monopolistic Competition

  • Many, various sized firms
  • Firms are "price makers"
  • Low barriers to entry (i.e. means that firms can enter/leave easily)
  • Firms break even in the long-run
  • Products sold are differentiated
  • Non-price competition is used
  • Firms are inefficient or left unregulated
  • Firms experience "excess capacity" in the long-run

Characteristics Compared to Other Market Structures

As stated earlier, the market structure of monopolistic competition has characteristics that are like perfect competition, but also like monopolies. The chart below details which characteristics are similar to the other market structures.

https://firebasestorage.googleapis.com/v0/b/fiveable-92889.appspot.com/o/images%2F-MOV8FJW1BhXk.png?alt=media&token=f6efc771-62f1-4bf0-b46d-e4023c05ca85

Monopolistic competition uses brand names and packaging as a type of non-price competition. The firms use this in order to stand out and be easily recognizable and distinguishable from their competitors. Think about Chick-fil-A; they are known for their customer service, making them different from other fast-food restaurants.

Another example is Nike's signature swoosh logo, which can be recognized all around the world. Nike also uses product attributes and services as non-price competition. This helps them distinguish how their products are different from the others in the market. They may show how their shoes' soles provide consumers with more speed than other brands, thus enticing consumers to purchase their product.

The final method used for non-price competition is advertising. Monopolistically competitive firms use advertising to generate demand for their product and to make consumer demand more elastic, meaning consumers will become more willing to switch from one product to another.

Graphing Monopolistic Competition

Monopolistic competitors can earn positive, negative, or zero economic profit in the short run, and they will break even in the long run (i.e. earn a normal profit) because of low barriers to entry/exit. The graph for a monopolistically competitive firm is very similar to a monopoly, and many people think they look almost identical. The main difference in the elasticity of the demand curve. The demand curve is more elastic in monopolistic competition than it is in a monopoly mainly because there are many more firms in monopolistic competition.

You can see in the graph below that both the demand (D) and marginal revenue (MR) curves are more elastic. We still identify profit-maximizing output and price the same way in monopolistic competition as we do in a monopoly. We identify output where MR=MC, and then go up to the demand curve and over to find the price.

https://firebasestorage.googleapis.com/v0/b/fiveable-92889.appspot.com/o/images%2F-ed5m2hjG1Iid.png?alt=media&token=9e36d6bf-c93a-4106-994f-1b55be5c0768

Monopolistic Competition Earning a Profit

When a monopolistically competitive firm is earning a profit, the average total cost (ATC) will be located below the price on the graph. The section between the price and ATC make up the profit area.

https://firebasestorage.googleapis.com/v0/b/fiveable-92889.appspot.com/o/images%2F-RCyOhGy2JWVL.png?alt=media&token=d0d7397c-a378-4187-b109-898902ce0713

Monopolistic Competition Earning a Loss

When a monopolistically competitive firm is earning a loss, the average total cost curve will be located above the price on the graph. The section between the price and ATC is labeled as the amount of the loss.

https://firebasestorage.googleapis.com/v0/b/fiveable-92889.appspot.com/o/images%2F-2v5vpWDfPgX7.png?alt=media&token=ba51a6b1-b4e1-4974-b74d-29d6c5da7391

Monopolistic Competition in the Long-Run

When a monopolistically competitive firm is in the long-run, the economies of scale portion of the ATC curve will be tangent to the demand curve at the profit-maximizing price level. When drawing this graph, it is very important to make sure it is tangent in the economies of scale (downward-sloping) region because we do not want to indicate that the firm is productively efficient by having it tangent at minimum ATC.

https://firebasestorage.googleapis.com/v0/b/fiveable-92889.appspot.com/o/images%2F-hVe6vQZGOC6T.png?alt=media&token=60dae475-077b-4f15-aa49-dca0eb858cc1

Going from Short Run to Long Run

When monopolistic firms earn a profit in the short run, it compels firms to enter which provides more close substitutes and less market share for the existing firms. This leads to the demand and MR curves shifting left together so that the demand curve becomes tangent with ATC.

When monopolistic firms earn a loss in the short run, it compels firms to exit which provides less close substitutes and more market share for the existing firms. This leads to the demand and MR curves shifting right together so that the demand curve becomes tangent with ATC.

Excess Capacity

Excess capacityย is the difference between a firm's current inefficient level of production and the productively efficient level of output.

https://firebasestorage.googleapis.com/v0/b/fiveable-92889.appspot.com/o/images%2F-QEJyFkgxo8yB.png?alt=media&token=70b6c8db-6df1-4d2d-8c45-76079d09b943

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