Monopolistic competition

assumptions

• small and many firms

• differentiated goods

• action of 1 firm is unlikely to affect its competitors

• low barriers of entry

• short run profit maximiser

• certain degree of market power (brand loyalty, patents, copyrights)

• demand curve is more elastic than monopoly, but less elastic than PCM
  

how can product differentiation be achieved

• physicsl difference

• quality difference

• locations

• services

• product image

price competition

occurs where a firm lowers its price to attract consumers away from rival firms, thus increasing sales at the expense of other firms

non price competition

occurs where firms use methods other than price reductions to attract consumers from rivals

monpolistic firms engage heavily in product differention through research

abnormal profit SR

• ar > ac

• profit will attract new firms. new entrants offer substitutes, reducing the original consumer base and shifting demand to the left. the decrease in demand continues until firms start to make normal profit in the long run.

normal profit SR

• ar=ac

• firms notice that industry is making profit, so new entrants enter the market. original firm’s demand shift to the left again, potentially leading to loss

• firms arent allocatively efficienct in SR and LR, failing to produce at where P = MC

• underallocation of resources

loss is SR

• ac > ar

• due to low barriers, firms operating at a loss in the long run will exit the industry. as firms exist, demand for remaining firms will shift to the right until they make normal profit in the long run.