Monopolistic competition

PMT

What are the characteristics of monopolistically competitive markets?

* Firms are short run profit maximisers
* Product differentiation but lots of relatively close substitutes so high XED
* Large number of buyers and sellers
* Firms have same but weak market power
* Firms compete via NON- PRICE competition
* No barriers to entry or exit
* Imperfect info
* E.g. hairdressers or regional plumbers

Draw and explain SR monop comp diagram

MONOPOLY DIAGRAM

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Short run:

* Firms profit maximise at the point MC = MR.
* The area P1C1AB represents the supernormal profits that firms in a monopolistically competitive market earn in the short run. → BOX UP FROM PROFIT MAX AND ACROSS AT AC INTERSECT

Draw and explain LR monop comp diagram

AC SHIFTS TO THE SIDE STILL TOUCHING AR

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Long run:

* New firms enter the market since they are attracted by the profits that existing firms are making.
* This makes the demand for the existing firms’ products more price elastic which shifts the AR curve (the demand curve) to the left.
* Consequently, only normal profits can be made in the long run. The long run equilibrium point is P1Q1.
* Firms can try and stay in the short run by differentiating their products and innovating.

Pros of monopolistically competitive markets

1. Allocatively efficient in both short run and long run (P>MC)
2. Wide product variety for consumers
3. More realistic then P/C
4. SR supernormal profits could increase dynamic efficiency via investment in R+D

Cons of monopolistically competitive markets

1. Productively inefficient in SR and LR (excess capacity from not fully exploiting FoPs, not operating at bottom of AC curve)
2. Dynamic efficiency may be limited in LR in losing supernormal profits
3. x inefficiency - little incentive to minimise costs