It is a market
structure where a large number of small firms produce non-homogenous products
and where there are no barrier to entry and exit
Monopolistic competition is a type of
imperfect competition such that one or two producers sell products that are
differentiated from one another as goods but not perfect substitutes (such as
from branding, quality, or location). In monopolistic competition, a firm takes
the prices charged by its rivals as given and ignores the impact of its own
prices on the prices of other firms.
Monopolistic
competition is a type of competition within an industry where:
1. All firms produce similar yet not perfectly substitutable products.
2. All firms are able to enter the industry if the profits are attractive.
3. All firms are profit maximizers.
4. All firms have some market power, which means none are price takers.
1. All firms produce similar yet not perfectly substitutable products.
2. All firms are able to enter the industry if the profits are attractive.
3. All firms are profit maximizers.
4. All firms have some market power, which means none are price takers.
Assumptions:
1.
There are large number
of buyers and sellers in the market and acts independently.
2.
No barriers to entry and
exit
3.
Firms are short run
profit maximizers. (MR=MC)
4.
Products can be similar
but with slightly differentiated but highly substitutable
The downward sloping demand curve:
If a firm produces a product with a slight
difference from that of competitor, it will gain some market power. It can
raise the price up to a certain level without losing its customer, but if it increases
its price too high it will lose its market as there are many firms making close
substitute of the product. Small change in price can result to large change in
quantity demanded as consumer switch to close substitutes. Hence the demand is
relatively elastic and downward sloping.
Short
Run:
·
There is the
possibility of short run supernormal profits or losses.
·
This is shown on the
graph, where the shaded area represents supernormal profits.
Long
Run:
·
Lack of significant
barriers to entry and exit → only normal profits being made in the long run.
·
Short-run supernormal
profit will induce new entry.
·
This means that the
demand curve will shift to the left until it is tangential to the average cost
curve (AR = AC).
·
Similarly, if losses
are being made in the short run, some firms will leave the market, restoring
long run equilibrium.