Wednesday, May 9, 2012

Monopolistic Competition

What is a monopolistic competition?
A monopolistic competition is an imperfect competition in which many firms sell a product that has product differentiation. An example would be the hamburger market, where there are many stores selling hamburgers, but the taste and quality of the burgers from each store are slightly different. The firms in a monopolistic competition are not price-takers, but they face a very elastic demand due to the availability of substitutes.

Also, there's an ease of entry and exit for a monopolistic competition

In order to differentiate their products, firms in a monopolistic often rely on advertisements to create brand names, to increase market share.

In the short Run
In the short run, the graph of a firm in monopolistic competition is very similar to that of a monopoly. The marginal cost curve is different from the average revenue curve, the firm produces at a point where MR=MC, and it can earn economic profit by charging the consumers at where the quantity intersects with the demand curve..

The only difference is that the demand is more elastic, and therefore the demand and MC curves look more "flat".

In the Long Run
In the long run, the average cost curve becomes tangential to the average revenue curve. This is because that if the firms in the market are earning economic profit, new firms will enter the market; and if firms are losing economic profit, they will simply drop out.

A monopolistic competition is not allocatively efficient, since the the marginal cost is less than the price.

It is also not productively efficient, because the average total cost is not minimized. Instead, it has excess capacity— its marginal cost is still less than the average cost, and it could have produced more.