Monopolistic Competition

1903-1982

1899-1967

What is monopolistic competition?

It is a common market structure in which firms have many competititors, but each one sells a slightly different product. The market structure was first identified in the 1930s by the american economics Edward Chamberlin and the english economics Joan Robinson.

So what are the characteristics of monopolistic competition?

• The industry is made up of a fairly large number of firms
• The firms are small, relative to the size of the industry. This means that the actions of one firm are unlikely to have a significant effect on its competitors- the firms assume they are able to act independently of each other
• The firms all produce slightly differentiated products. This means that it is possible for a consumer to tell one firms product from another
• Firms are completely free to enter or leave the industry- so there are no barriers to entry or exit
• Knowledge is widely spread between participants, but it is unlikely  to be perfect                   For example, diners can review all the menus available from restaurants in a town, before they make their choice. Once inside the restaurant, they can view the menu again, before ordering. However, they cannot fully appreciate the restaurant or the meal until after they have dined.

Monopolistic competition in the short run:

At profit maximisation, MC = MR, and output is Q and price P. Given that price (AR) is above ATC at Q, abnormal profits are possible (area PABC).As new firms enter the market, demand for the existing firm’s products becomes more elastic and the demand curve shifts to the left, driving down price. Eventually, all abnormal profits are eroded away.

Monopolistic competition in the long run:
Abnormal profits attract in new entrants, which shifts the demand curve for existing firm to the left. New entrants continue until only normal profit is available. At this point, firms have reached their long run equilibrium.

Inefficiency:

The firm is allocatively and productively inefficient in both the long and short run.There is a tendency for excess capacity because firms can never fully exploit their fixed factors. This means they are productively inefficient in both the long and short run. However, this is may be outweighed by the advantages of choice.

Examples of monopolistic competition:

• nail salons
• car mechanics
• plumbers
• jewellers
• hotels
• restaurants

Advantages of monopolistic competition:

• Markets are contestable, because there are no entry barriers
• There is more choice and freedom for consumers due to the product differentiation
• The market is more efficient than monopoly but less efficient than perfect competition - less allocatively and less productively efficient. However, they may be dynamically efficient, innovative in terms of new production processes or new products

Disadvantages of monopolistic competition:

• There is allocative inefficiency in the short run as well as in the long run
• Some differentiation does not create utility but generates unnecessary waste, such as excess packaging

All information was taken from : 

http://www.economicsonline.co.uk