Characteristics

• Many small sellers

• Many small buyers

• Slightly differentiated products

Monopolistic
• Each firm faces a slightly downward
Competition slope demand curve implying that
individual firm has some control over
price

Characteristics Characteristics

• Easy entry and exit
• Price elasticity of demand is higher the
smaller is the degree of product
differentiation
• Best level of output in SR is determined by
the intersection of MR & MC curves,
provided the price exceeds AVC
• If P<ATC, the firm incurs losses but
it minimising losses by continuing to
produce as long as P>AVC
• It is assumed that all firms have
similar cost and demand curve
• Thus, it is possible to consider a
representative firm

Short run equilibrium of the firm under monopolistic competition

Monopolistic competition Similar to monopoly
£
MC

AC

P
s
Equilibrium of the firm
ACs
in the short and long run
D

MR

O Qs Q

1
 Long run equilibrium of the firm under monopolistic competition
Long run equilibrium Similar to perfect competition

• LR demand curve is more price elastic than £

SR demand curve because of smaller market
share and greater range of competition MC

• At LR equilibrium, demand curve becomes AC

the tangent of AC curve A
PL
• A firm’s profits will be eliminated in the long
run only if the firm stands still and fails to find
new ways of differentiating its product
D
• Or fails to find new ways of lowering the cost MR
of producing its product. O QL Q

What Happens to Profits in the Long Run?

What Happens to Profits in the Long Run?
How Does Entry of New Firms Affect the Profits of Existing Firms?

The Short Run and the Long

Run For a Monopolistically
Competitive Firm

Don’t Confuse Zero Economic Profit with Zero Accounting Profit

9 of 10 of

Lessens Learnt Comparing Perfect Competition and Monopolistic

Competition
• Firms in monopolistic competition have some control
over price as there products are differentiated
Comparing Long-Run
Equilibrium under Perfect
Competition and
• As with perfect competition, they can earn economic Monopolistic Competition
profits in SR

• But there are no long term economic profit in

monopolistic competition & P=AC

• Sometimes argued that firms in monopolistic competition

are inefficient as profit maximizing output does not
occur at the minimum point on form’s average cost curve
as in perfect competition

• However the reason in downward slopping demand curve

due to product differentiation
12 of

2
 Example
• Explain the process by which economic profits are
eliminated in a monopolistically competitive market
as compared to a perfectly competitive market. • Petleft, a pet mortuary in Shimla, offers complete funerals
for dogs. It is a monopolistic competitive environment.
• In a monopolistically competitive industry, Firms demand equation and long term total cost equation
are P =309.75 – Q and TC = 400Q – 20Q2+Q3. Find long run
excess profits are eliminated in the long-run
price, quantity and economic profit
through imperfect emulation of successful
product design, production systems, and
marketing efforts by both established and new • Soln.
competitors. • P = AC; 309.75 – Q = TC/Q=400-20Q+3Q2
• Excess profits are eliminated in a perfectly • Q = 9.5 and P = 300.25
competitive industry through expansion by • Since in LR, P=AC, economic profit is zero
established firms and entry of new firms, both
of whom offer identical products that are
perfect substitutes.

Herfindahl-Hirschman Index (HHI) Monopolistic Competition & Advertising

• HHI is a common measure of market concentration
and is used to determine market competitiveness • Advertising is one of the ways of product
differentiation
• A market with an HHI of less than 1,500 is considered to be a
competitive marketplace • Not useful for perfectly competitive and
• For Monopoly , HHI is 10,000 monopoly markets
• an HHI of 1,500 to 2,500 to be a moderately concentrated
marketplace** • In a monopolistically competitive market, each
• an HHI of 2,500 or greater to be a highly concentrated firm offering a brand that is virtually unique
marketplace
 1 firm, 100% market share (a monopoly): HHI = 1002 = 10,000 • It is profitable for such a firm to attract
 2 firms, each with a 50% market share: HHI = 502 + 502 = 5,000 consumers through advertising rather than
 4 firms, with market shares of 30%, 30%, 20%, and 20%:
HHI = 302 + 302 + 202 + 202 = 2,600
lowering price
 10 firms, each with market shares of 10%: HHI = 10(102) = 1,000

Monopolistic Competition & Advertising Features of the four market structures

• Expenditure on advertisement is seen to

increase the quality of sales of a firm
ForeignExchange
– by causing an outward shift on DD curve
– by making the product less elastic Doctors

• Optimal level of advertising is found at a Soft Drink

point when
– MR derived from advertising (MRA) = MC of
advertising (MCA) Railways

3
• A Good Drought Is Great For Business - For Politicians Monopsony
Supplying Tankers
http://www.ndtv.com/india-news/a-good-drought-is-great-for-business-for-politicians-supplying-tankers-
1395742?pfrom=home-lateststories
• Opposite to monopoly
• Monopsony power allow bigger firms to achieve
• Microsoft Antitrust purchasing economy of scale leading to lower
https://www.youtube.com/watch?v=pzR372vxWto
long-run average cost
– Monopsony power exists when one buyer faces little
• Is OPEC Really Still a Cartel? competition from other buyers for that labor or good, so
• https://www.youtube.com/watch?v=oTo0x7Hcwmw&ebc=ANyPxKo4zQn3GDs1lVwkjVXC7ma-
hrfyaAdWGrH3xlXTvFbmPBiPhawQ3KRcq-CIRnRPKKJl3w5YCqxi6PzI3i8Kx1HKDmKbNg they are able to set wages and prices for the labor or goods
they are buying at a level lower than the marginal revenue
created by that labor or good, there by minimizing costs
Political Capital Bloomberg TV and maximizing profits
https://www.youtube.com/watch?v=Hf7Kw6imySE
• Example: Amazon (If publishers don’t sell to Amazon at a discounted
• Kejriwal Bans Surge Pricing For Cabs, Is It Justified? price, they will miss out on selling to the biggest distributor of books), Coal
http://www.ndtv.com/video/player/left-right-centre/kejriwal-bans-surge-pricing-for-cabs-is-it-
justified/412747?video-top-shows Mines, Sugar Mills, Defence

Profit Maximisation for a Monopsony

• The marginal cost of employing
one more worker will be higher
than the average cost because
to employ one extra worker the
firm has to increase the wages
of all workers.
• To maximise the level of profit the
firm employs Q2 of workers where
the Marginal cost of labour
equals the Marginal Revenue
Product MRP = D
• A monopsony pays a wage of
W2 and employs Q2  producer
surplus
• In a competitive labour market, the
firm would be a wage taker. If they
tried to pay only W2, workers
would go to other firms willing to
pay a higher wage.