Principles of Economics

EGMC001
Monopolistic Competition: Unit 8

Learning Objectives:
 Understand the meaning and features of monopolistic competition
 Explain how price and output decisions are taken in monopolistic markets
 Understand the difference between monopolistic competition and monopoly
Features of Monopolistic
Competition
Large number of sellers

Product differentiation

Free entry and exit

Non-price competition

Lack of perfect knowledge

Monopolistic Competitive Firm Maximises Profits in the
Short Run

Price
MR=MC at point e: quantity
Marginal cost
Q
For Q, ATC is at point b

p a P>ATC, firm makes profit

Average total cost For Q, price=p at point a, on
Profit D curve
k b Average variable cost
c

Demand=Average revenue
e
Marginal revenue

0 Q Quantity per period

Monopolistic Competitive Firm Makes Normal Profits in
the Short Run
Price per unit
Marginal cost
MR=MC at point e: quantity Q
For Q, ATC is at point a
a Average total cost
p P = ATC, firm makes normal
Average variable cost profits
For Q, price=p at point a, on D
c curve

Demand=Average revenue
e
Marginal revenue

0 Q Quantity per period

Monopolistic Competitive Firm Minimizes Losses in the
Short Run
Price per unit
Marginal cost
MR=MC at point e: quantity Q
For Q, ATC is at point a
Average total cost
m a P<ATC, firm suffers a loss
Loss Average variable cost
p For Q, price=p at point b, on D
b
curve
c
Should this firm continue to
produce or shut down?
Demand=Average revenue
e
Marginal revenue

0 Q Quantity per period

Monopolistic Competition Vs Perfect Competition

Perfect Competition Monopolistic Competition

Product is identical (homogenous) and
there are large number of buyers as well
as sellers.
Since product is homogeneous as a
result uniform price exists in the
market.
Firm is a price-taker since the industry
decides the price.
Demand curve is perfectly elastic.
Perfect knowledge about the market is
available with buyer as well as seller.
There are large number of firms with unique
products which may be close substitutes but
not identical.
Differentiation in the product due to size,
shape, features, after sales service, brand
name etc. leads to variation in price.
Firm has limited price control and is a price
maker.
Demand curve slopes downwards and elastic
Buyers and Sellers are deprived of perfect
knowledge due to differentiation.

There is no selling cost since both buyers and Selling cost is generally high particularly due to
sellers possess perfect knowledge. promotional cost since buyers and sellers are
deprived of perfect knowledge. 
 Monopoly Vs Monopolistic Competition
Monopoly
Single seller who sells unique product with There are large number of firms with
no close substitutes.
There is full control over the market
because of single seller.
The demand curve is less elastic due to
absence of close substitutes.
Selling cost is less due to no close
substitutes.
Firm is a price-maker since firm and
industry are both the same entity.
Monopolistic Competition
differentiated products which may be close
substitutes but not identical.
There is no such full control due to large
number of sellers.
The demand curve is more elastic due to
presence of close substitutes.
Selling costs is generally since buyers and
sellers are deprived of perfect knowledge. 
Firm has limited control over price based
on product differentiation.
Efficiency

• Why monopolistic competition is inefficient?

• It may be assumed that a monopolistically competitive firm is slightly inefficient

because the company produces at an output where the average total cost is not a
minimum.

• A market that is monopolistically competitive is an inefficient market structure

because in the long run marginal cost is less than price.
Allocative Efficiency

• The output level produced is such that it maximizes social welfare. More
specifically, allocative efficiency occurs when the sum total of the consumer
surplus and the surplus of the producer is maximized.

• Equilibrium is set to be established when the firm's equilibrium price is equal

to its MC. It means that a product’s price is equal to its marginal benefits
which is equivalent to the product’s marginal cost. Under monopoly price
always exceeds its marginal cost, the market can never be efficient in
allocative terms.
Productive Efficiency

• Productive efficiency occurs when the market makes efficient use of all its
resources. It refers to minimization of average cost of production in the long-
run.

• This happens under perfect competition where free entry and exit and product
uniformity ultimately achieves equilibrium at the point of tangency between
demand curve and lowest point on long-run average cost-curve.
THANKS!