microeconomics intro lecture 9

What is monopolistic competition?

A market structure with many firms selling similar but differentiated products.

What are the three assumptions of monopolistic competition?

• Many firms

• Free entry

• Differentiated products

What is product differentiation?

When firms sell products that are similar but not identical, making them different from competitors.

Why do firms in monopolistic competition have some control over price?

Because their products are differentiated, so customers may prefer one firm's product over another

What is the profit-maximising condition in monopolistic competition?

MR = MC (Marginal Revenue = Marginal Cost).

Can firms earn supernormal profit in the short run?

Yes

Why can firms earn supernormal profits in the short run?.

Because new firms have not yet entered the market to increase competition

What happens when firms earn supernormal profits?

New firms enter the market because entry is free.

What happens to demand when new firms enter?

Demand for each existing firm falls because customers are shared among more firms.

What happens to supernormal profits in the long run?

They are competed away until firms earn only normal profit.

What two conditions exist in long-run equilibrium?

• MR = MC

• AR = AC

What is excess capacity (under-utilisation of capacity)?

When a firm produces below its maximum efficient level of output.

Why do firms have excess capacity in monopolistic competition?

Because they earn only normal profit before reaching the minimum average cost output.

Compared with perfect competition, monopolistic competition has…..

Higher prices and lower output.

Give two limitations of the monopolistic competition model.

• Imperfect information.

• Entry may not be completely free.

What other limitations does the model have?

• Difficult to identify the industry demand curve.

• Ignores the importance of non-price competition.

What are the key characteristics of monopolistic competition?

• Many firms

• Free entry

• Differentiated products

• Some price-setting power

• Firms earn normal profit in the long run

Why do firms only earn normal profit in the long run?

Because free entry attracts new firms, increasing competition and reducing profits until only normal profit remains.