F&D P2: Monopolistic Competition

What is Monopolistic Competition (MPC)?

A market structure with a relatively large number of small firms selling similar but differentiated products, low barriers to entry/exit, and imperfect information. Sellers have some market power due to product differentiation.

Why is there no single market demand curve in MPC? (Reason for no single DD curve)

Product differentiation leads to a range of prices, and consumers/sellers lack perfect knowledge, so no single equilibrium price.

What is a Large number of small buyers and sellers? (MPC Characteristic)

Each firm has a relatively small market share due to low barriers to entry.

What are the implications of small market share?

Limited power to influence price, price can deviate slightly from average market price, limited ability to set price above MC.

How do MPC firms set price?

Each firm sets price independently without worrying about rival reactions due to small market share.

Why is Collusion impossible in MPC?

Large number of small, differentiated firms makes coordination difficult.

What are Low barriers to entry and exit? (MPC Characteristic)

Relatively low start-up costs, easy to copy technology, mobile FOP -> easy for firms to enter/leave, ensuring large number of firms.

What types of profits are made in MPC in the Long Run?

Only normal profits due to very low barriers to entry -> potential entrants easily erode supernormal profits.

What strategies are employed by MPC firms?

Product differentiation via non-pricing competition to maintain customer loyalty and market power, rather than large-scale advertising/R&D.

What are Differentiated Products? (MPC Characteristic)

Products are slightly differentiated, meaning many close substitutes are available.

What are Real Physical Differences? (Form of Product Differentiation)

Product altered by adding features, using different materials/workmanship (e.g., hawker food variations).

What are Imaginary Differences? (Form of Product Differentiation)

Product differentiated by design, packaging, branding, promotion methods (non-price competitive techniques).

What are Differences in Conditions of Sale? (Form of Product Differentiation)

Differences in shop location, quality of service, ambience.

What is the implication of Product Differentiation for MPC firms?

Each firm has some control over its own prices, resulting in a downward sloping demand curve (AR curve).

How elastic is demand for MPC products?

Relatively price elastic (large number of close substitutes), suggesting high PED and CED compared to monopoly/oligopoly.

What is Imperfect Knowledge? (MPC Characteristic)

Sellers and buyers have incomplete information regarding production methods and prices.

What types of profits can a profit-maximising MPC firm make in the Short Run?

Supernormal, normal, or subnormal profits, as long as TR > TVC.

What is the Long Run Equilibrium for a Profit-Maximising MPC Firm?

Only make normal profits due to low barriers to entry and exit.

How do MPC firms adjust from SR Supernormal Profits to LR Normal Profits?

Supernormal profits attract new firms -> entry increases market supply -> price falls -> demand for existing firm's product falls and becomes more price elastic -> AR curve shifts left/more elastic until tangent to AC, making normal profits.

How do MPC firms adjust from SR Subnormal Profits to LR Normal Profits?

Subnormal profits (not covering TVC) force firms to exit -> fewer firms -> demand for remaining firms' products rises and becomes less price elastic -> AR curve shifts right/less elastic until tangent to AC, making normal profits.