Monopolistic competition

Assumptions of monopolistic competition:

• Differentiated goods (similar but not same)

• Many buyers and sellers

• Imperfect information 

• Low barriers to entry (some but not many)

*Differentiated goods allow them to be price makers (though limited power as it is still competitive)

Types of product differentiation

• Physical:

  • Material, shape, size, color 

• Marketing:

  • Branding, social media, advertisement, packaging

• Distribution:

  • Private stores, online, retail 

Why might economists have a problem with monopolistic competition:

Since it is very competitive(low barriers to entry), firms may use advertisements to gain attraction. This can be seen as a misallocation of resources, as adverts do not benefit consumers or producers 

monopolistic competition long run - normal profit

Monopolistic competition short run (subnormal/loss) + why return to normal in long run

Returns to normal profit in long run

• Low profits repel firms - no profit incentive (low barriers to exit)

• Decreases supply (shift inwards), increases price

• AR and MR shift outwards, AC and AR touch 

Monopolistic competition short run (supernormal) + why return to normal in long run

Returns to normal profit in long run

• High profits attract firms - profit incentive (low barriers to entry)

• Increases supply (shift outwards), decreases price

• AR and MR shift inwards, AC and AR only touch once

Shifts in AC and MC

Fixed costs only affect AC
Variable costs affect AC and MC

Efficiencies in short/long run

• No allocative efficiency

• No productive efficiency