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ACDC Leadership 2019

Topic 4.4-

Monopolistic Competition

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Student Tip

Monopolistic competition practice can serve as a great way to see how well you understand both perfect competition and monopoly.

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Since it’s sort of the middle ground between the two you should be comfortable making comparisons between monopolistic competition and the other market structures you have learned so far.

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Characteristics of Monopolistic Competition:

  • Relatively Large Number of Sellers
  • Differentiated Products
  • Some control over price
  • Easy Entry and Exit (Low Barriers)
  • A lot of non-price competition (Advertising)

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Perfect

Competition

Pure

Monopoly

Monopolistic

Competition

Oligopoly

Pure

Monopoly

Monopolistic

Competition

Oligopoly

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Considering the characteristics of monopolistic competition...

Create a list of markets (not specific companies) that could be considered monopolistic competition.

For reference:

  • Relatively Large Number of Sellers
  • Differentiated Products
  • Some control over price
  • Easy Entry and Exit (Low Barriers)
  • A lot of non-price competition (Advertising)

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Examples:

  1. Fast Food Restaurants
  2. Furniture companies
  3. Jewelry stores
  4. Hair Salons
  5. Clothing Manufacturers

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Monopolistic Qualities

    • Control over price of own good due to differentiated product
    • D greater than MR
    • Plenty of Advertising
    • Not efficient

“Monopoly” + ”Competition”

Perfect Competition Qualities

    • Large number of smaller firms
    • Relatively easy entry and exit
    • Zero Economic Profit in Long-Run since firms can enter

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  • Goods are NOT identical.
  • Firms seek to capture a piece of the market by making unique goods.
  • Since these products have substitutes, firms use NON-PRICE Competition.

Examples of NON-PRICE Competition

    • Brand Names and Packaging
    • Product Attributes
    • Service
    • Location
    • Advertising (Two Goals)

1. Increase Demand

2. Make demand more INELASTIC

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Differentiated Products

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Differentiated Products

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Drawing Monopolistic Competition

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Student Tip

Along with perfectly competitive firms and monopolies, monopolistic competition is one of the key graphs that you will be asked to draw on the AP exam.

Reminder: a monopolistically competitive firm in the short run is 100% identical to a regular non-price discriminating monopoly. The big difference is the long-run since monopolistically competitive firms make no economic profit.

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D

MR

MC

ATC

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Q

Monopolistic Competition is made up of prices makers so MR is less than Demand

In the short-run, it is the same graph as a monopoly making profit

In the long-run, new firms will enter, driving down the DEMAND for firms already in the market.

P

Q1

P1

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D

MR

MC

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Q

P

Firms enter so demand falls until there is no economic profit

ATC

Q1

P1

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D

MR

MC

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Q

P

Firms enter so demand falls until there is no economic profit

ATC

QLR

PLR

Price and quantity falls and TR=TC

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D

MR

MC

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Q

P

LONG-RUN EQUILIBRIUM

ATC

QLR

PLR

Quantity where MR =MC up to Price = ATC

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Why does DEMAND shift?

When short-run profits are made…

    • New firms enter.
    • New firms mean more close substitutes and less market shares for each existing firm.
    • Demand for each firm falls.

When short-run losses are made…

    • Firms exit.
    • Result is less substitutes and more market shares for remaining firms.
    • Demand for each firm rises.

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Student Tip

Students have not been asked to draw a monopolistic competition model and then shift D, MR, or the cost curves. But, you might be asked to explain how firms transition from short run to long-run.

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In other words, you probably don’t need to draw shifts, but should be comfortable knowing the determinants of those shifts, as well as how MC=MR and the relationship between P and ATC will be affected by the given changes.

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D

MR

MC

ATC

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Q

What happens when there is a loss?

In the long-run, firms will leave, driving up the DEMAND for firms already in the market.

P

Q1

P1

In the short-run, the graph is the same as a monopoly making a loss

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D

MR

MC

ATC

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Q

Firms leave so demand increases until there is no economic profit

P

Q1

P1

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D

MR

MC

ATC

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Q

Firms leave so demand increases until there is no economic profit

P

QLR

PLR

Price and quantity increase and TR=TC

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Are Monopolistically Competitive Firms Efficient?

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D

MR

MC

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Q

P

Long- Run Equilibrium

ATC

QLR

PLR

Not Allocatively Efficient because P ≠ MC

Not Productively Efficient because not producing at Minimum ATC

QSocially Optimal

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D

MR

MC

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Q

P

ATC

QLR

PLR

This firm also has EXCESS CAPACITY

QSocially Optimal

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Long- Run Equilibrium

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  • Given current resources, the firm can produce at the lowest costs (minimum ATC) but they decide not to.
  • The gap between the minimum ATC output and the profit maximizing output.
  • Not the amount underproduced

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Excess Capacity

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D

MR

MC

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Q

P

ATC

QLR

PLR

The firm can produce at a lower cost but it holds back production to maximize profit

QProd Efficient

Excess Capacity

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Long- Run Equilibrium

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Practice Question

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Assume there is a monopolistically competitive firm in long-run equilibrium. If this firm were to realize productive efficiency, it would:

A) have more economic profit.

B) have a loss.

C) also achieve allocative efficiency.

D) be under producing.

E) be in long-run equilibrium.

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Practice Question

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Assume there is a monopolistically competitive firm in long-run equilibrium. If this firm were to realize productive efficiency, it would:

A) have more economic profit.

B) have a loss.

C) also achieve allocative efficiency.

D) be under producing.

E) be in long-run equilibrium.

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2008 Audit Exam

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2008 Audit Exam