Monopolistic

Monopolistic
Competition
Competition
 Characteristics
• Many small sellers

• Many small buyers

• Slightly differentiated products

• Each firm faces a slightly downward

slope demand curve implying that
individual firm has some control over
price
 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
 Characteristics
• 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
 Monopolistic
Monopolistic competition
competition

Equilibrium
Equilibrium of
of the
the firm
firm
in
in the
the short
short and
and long
long run
run
Short run equilibrium of the firm under monopolistic competition
Similar to monopoly
£
MC

AC

Ps

ACs

D
MR

O Qs Q
 Long run equilibrium
• LR demand curve is more price elastic than
SR demand curve because of smaller market
share and greater range of competition

• At LR equilibrium, demand curve becomes the

tangent of AC curve

• 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

• Or fails to find new ways of lowering the

cost of producing its product.
 Long run equilibrium of the firm under monopolistic
competition
Similar to perfect competition
£

MC

AC
A
PL

D
MR
O QL Q
What Happens to Profits in the Long Run?

Don’t Confuse Zero Economic Profit with Zero Accounting Profit

9 of 19
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

10 of 19
 Lessens Learnt
• Firms in monopolistic competition have some control over
price as there products are differentiated

• As with perfect competition, they can earn economic

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

Comparing Perfect Competition and Monopolistic
Competition

Comparing Long-Run
Equilibrium under Perfect
Competition and
Monopolistic Competition

12 of 19
• Explain the process by which economic profits are
eliminated in a monopolistically competitive market
as compared to a perfectly competitive market.

• In a monopolistically competitive industry,

excess profits are eliminated in the long-run
through imperfect emulation of successful
product design, production systems, and
marketing efforts by both established and new
competitors.
• Excess profits are eliminated in a perfectly
competitive industry through expansion by
established firms and entry of new firms, both
of whom offer identical products that are
perfect substitutes.
 Example

• Petleft, a pet mortuary in Shimla, offers complete funerals

for dogs. It is a monopolistic competitive environment.
Firms demand equation and long term total cost equation
are P =309.75 – Q and TC = 400Q – 20Q2+Q3. Find long run
price, quantity and economic profit

• Soln.
• P = AC; 309.75 – Q = TC/Q=400-20Q+3Q2
• Q = 9.5 and P = 300.25
• Since in LR, P=AC, economic profit is zero
 Herfindahl-Hirschman Index (HHI)
• HHI is a common measure of market
concentration and is used to determine market
competitiveness

• Si  Market share
 HHI
 1 firm, 100% market share (a monopoly): HHI = 1002 =
10,000
 2 firms, each with a 50% market share: HHI = 502 + 502 =
5,000
 4 firms, with market shares of 30%, 30%, 20%, and 20%:
HHI = 302 + 302 + 202 + 202 = 2,600
 10 firms, each with market shares of 10%: HHI = 10(102) =
1,000
• A market with an HHI of less than 1,500 is considered to be a
competitive marketplace
• For Monopoly , HHI is 10,000
• an HHI of 1,500 to 2,500 to be a moderately concentrated
marketplace**
• an HHI of 2,500 or greater to be a highly concentrated marketplace
Monopolistic Competition & Advertising
• Advertising is one of the ways of product
differentiation

• Not useful for perfectly competitive and

monopoly markets

• In a monopolistically competitive market, each

firm offering a brand that is virtually unique

• It is profitable for such a firm to attract

consumers through advertising rather than
lowering price
Monopolistic Competition & Advertising
• Expenditure on advertisement is seen to
increase the quality of sales of a firm
– by causing an outward shift on DD curve
– by making the product less elastic

• Optimal level of advertising is found at a

point when
– MR derived from advertising (MRA) = MC of
advertising (MCA)
Features of the four market structures

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 Monopsony
• Opposite to monopoly
• Monopsony power allow bigger firms to achieve
purchasing economy of scale leading to lower
long-run average cost
– Monopsony power exists when one buyer faces little
competition from other buyers for that labor or good, so
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
and maximizing profits
• Example: Amazon (If publishers don’t sell to Amazon at a discounted
price, they will miss out on selling to the biggest distributor of books), Coal
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.