Unit 7

Monopolistic competition
Monopolistic competition
 Monopolistic competition is a form of imperfect
competition and can be found in many real world markets
ranging from clusters of sandwich bars, other fast food
shops and coffee stores in a busy town centre to pizza
delivery businesses in a city or hairdressers in a local area.

Under, the Monopolistic Competition, there are a large
number of firms that produce differentiated products
which are close substitutes for each other. In other words,
large sellers selling the products that are similar, but not
identical and compete with each other on other factors
besides price.
Monopolistic competition
 In other words Monopolistic competition is a market
structure which combines elements of monopoly and
competitive markets.
 Essentially a monopolistic competitive market is one
with freedom of entry and exit, but firms can
differentiate their products.
 Therefore, they have an inelastic demand curve and so
they can set prices.
 However, because there is freedom of entry,
supernormal profits will encourage more firms to enter
the market leading to normal profits in the long term.
Features of Monopolistic competition

 Features:
 Product Differentiation: This is one of the
major features of the firms operating under
the monopolistic competition, that produces
the product which is not identical but is
slightly different from each other. The
products being slightly different from each
other remain close substitutes of each other
and hence cannot be priced very differently
from each other.
 Large number of firms: A large number of
firms operate under the monopolistic
competition, and there is a stiff competition
between the existing firms. Unlike the perfect
competition, the firms produce the
differentiated products which are substitutes
for each other, thus make the competition
among the firms a real and a tough one
 Free Entry and Exit: With an intense
competition among the firms, the entity
incurring the loss can move out of the
industry at any time it wants. Similarly, the
new firms can enter into the industry freely,
provided it comes up with the unique feature
and different variety of products to outstand
in the market and meet with the competition
already existing in the industry.
 Some control over price: Since, the products
are close substitutes for each other, if a firm
lowers the price of its product, then the
customers of other products will switch over to
it. Conversely, with the increase in the price of
the product, it will lose its customers to others.
Thus, under the monopolistic competition, an
individual firm is not a price taker but has some
influence over the price of its product.
 Heavy expenditure on Advertisement and
other Selling Costs: Under the monopolistic
competition, the firms incur a huge cost on
advertisements and other selling costs to
promote the sale of their products. Since the
products are different and are close
substitutes for each other; the firms need to
undertake the promotional activities to
capture a larger market share.
 Product Variation: Under the monopolistic
competition, there is a variation in the products
offered by several firms. To meet the needs of the
customers, each firm tries to adjust its product
accordingly. The changes could be in the form of
new design, better quality, new packages or
container, better materials, etc. Thus, the amount
of product a firm is selling in the market depends
on the uniqueness of its product and the extent to
which it differs from the other products
 Price and Output Determination in
Monopolistic competition
 In monopolistic competitive market the product is
differentiated between firms, each firm doesn’t face a
perfectly elastic demand for its product. As such , the firm
faces with a downward slopping demand curve for its
product .
 Equilibrium in Short Run:
 The short-run equilibrium of a monopolistic competitive
organization is the same as that of an organization under
monopoly.
 In the short run, an organization under monopolistic competition
attains its equilibrium where marginal revenue equals marginal
cost and sets its price according to its demand curve. This implies
that in the short run, profits are maximized when MR=MC.
 Price and Output Determination in
Monopolistic competition
 And MC cuts MR from below.
 Like monopoly the firm can be in 3 conditions
 Excess profit (fig. A)
 Normal profit( fig. B)
 And loss (fig. C)
 The equilibrium quantity is determined by
the MC and MR and profit or loss is
measured with the help of AC and AR.
Price and Output Determination in
Monopolistic competition
 Price and Output Determination in
Monopolistic competition
 Equilibrium in Long-run:
 In the short-run , the firm under monopolistic
competition can earn excess profit but in long
run it disappears. This is because of the free
entry of the new firm in the group. As new firms
enter , they start producing, supply will increase
and the price will fall as result the AR curve shifts
to the left and therefore the excess profit will be
competed away and there will be normal profit
only.
 Price and Output Determination in
Monopolistic competition
 Another point to be noted is that in the long-
run AR will be more elastic (flatter) . There
will be large number of substitutes in the
market in long-run . Therefore in long-run
there will be only normal profit. (AR=LAC)
Price and Output Determination in
Monopolistic competition
 Price and Output Determination in
Monopolistic competition
 Points to be noted:
 In short run: 1) MR=MC
 2)MC cuts MR from Below
 In long-run : Both condition of short-run plus
AR=AC