Monopolistic Competition

Clothing
• Many small firms
• low barriers to entry – easy entry and exit
• product differentiation
• brand loyalty makes the demand curve less
price elastic. Thus, they face a downward
sloping demand curve.
Exhibit 2 and 3, p. 249-250 show the graph
for monopolistic competition.

Note, that eventually competition enters

until Price equals ATC. Thus, there are no
long run economic profits. However, they
are also not at ATC min., so they are not
efficient.
 How do they Differentiate their
products?
• Product Attributes
• Service
• Location
• Brand Names and Packaging
• Some Control Over Price
• Role of Advertising
 PRICE AND OUTPUT IN
MONOPOLISTIC COMPETITION in the SR
Expect New Competitors MC
ATC

P1
Price and Costs

A1

Economic
Profits D
MR
Q1
Quantity
 While Monopolistically
Competitive firms make a short-
run profit, since there are no
barriers to entry, this attracts
competition, and eventually that
reduces their economic profit to
zero in the LR.
 PRICE AND OUTPUT IN
MONOPOLISTIC COMPETITION
Long-Run Equilibrium MC
Normal
Profit ATC
Only
P3
Price and Costs

= A3

D
MR
Q3
Quantity
 MONOPOLISTIC COMPETITION
AND EFFICIENCY
• Not Productively Efficient
 Minimum ATC
• Not Allocatively Efficient
Price  MC
• Excess Capacity
Graphically…
 MONOPOLISTIC COMPETITION
AND EFFICIENCY
Long-Run Equilibrium MC
Price is Not
= Minimum ATC
ATC
P3
Price and Costs

= A3
Price  MC

D
MR
Q3
Quantity