Monopolistic competitionAn industry in monopolistic competition is one made up of a large number of small firms who produce goods which are only slightly different from that of all other sellers. It is similar to perfect competition with freedom of entry and exit for firms and any supernormal profits earned in the short-run will be competed away in the long-run as new firms enter the industry and compete away the profits. Show
Assumptions of monopolistic competitionIn monopolistic competition, as with perfect competition, we make a number of assumptions. However, do not get muddled by the word monopolistic in the title. As a form of competition, this is closest to perfect competition and nowhere near the monopoly end of the scale. The reason for the name is that in monopolistic competition we drop the assumption from perfect competition of homogeneity of products and so each firm can develop their own 'brand' of product. This means that each firm has a 'monopoly' over their brand, but there is still a large number of firms. The main assumptions are:
Examples of monopolistic competitionPetrol stations, restaurants, hairdressers and builders are all examples of monopolistic competition. Monopolistic competition is a common form of competition in many areas. A typical feature is that there is only one firm in a particular location. There may be many chip shops in town but only one in a particular street. People may be prepared to pay higher prices than go elsewhere, or they may simply prefer this 'brand' of fish and chips. Monopolistic competition in the short-runAs with other market structures, profits are maximized in monopolistic competition where MC = MR. The AR and MR curves are more elastic than for a monopolist as there are more substitutes available. The profits depend on the strength of demand, the position and elasticity of the demand curve. In the short run therefore firms may be able to make supernormal profits. This situation is shown in the diagram below. Figure 1 Equilibrium in monopolistic competition in the short-run Monopolistic competition in the long runIn the long run firms will enter the industry attracted by the supernormal profits. This will mean that demand for the product of each firm will fall and the AR (demand curve) will shift to the left. Long run equilibrium occurs where only normal profits are being made as new firms will keep entering as long as there are supernormal profits to be made. In equilibrium, the demand curve (AR) will be tangential to the firm's long run average cost curve as shown in the diagram below. Figure 2 Equilibrium in monopolistic competition in the long run We can see this change between the short-run and long run clearly if we combine Figures 1 and 2 together. Figure 3 shows the changes taking place as new firms enter the market. Figure 3 Changes in equilibrium in monopolistic competition short-run to long run Limitations of modelThe monopolistic competition model has various limitations and these include:
Efficiency in monopolistic competition
What are the assumptions of the theory of monopolistic competition?The main assumptions are: Large number of firms - each firm has an insignificantly small share of the market. Independence - as a result of a large number of firms in the market, each firm is unlikely to affect its rivals to any great extent.
Which of the following is not an assumption of theory of perfect competition?The correct answer is C. restrictions on entry into the market.
Which of the following is one of the assumptions apply to monopolistic competition?One of the assumptions of monopolistic competition is that firms produce differentiated products....
What are the 4 conditions to monopolistic competition?What are the four conditions to monopolistic competition? The four conditions to monopolistic competition are a large number of firms, similar but not perfectly substitutable products, low barriers to entry, and less than perfect information.
|