Monopolistic Competition
Monopolistic Competition
Monopolistic Competition
Monopolistic competition is similar to perfect competition. However all the products they sell are slightly differentitated. Due to this firms in monopolistic competition have a downward sloping demand curve and are able to set price.
Example
- Hairdressers – All hairdressers differentiate themselves through the price, quality and experience they provide to customers.
- Restaurants – Although they all provide food their products are differentiated in terms of price, quality and taste. Low barriers to entry also exist in this industry because it’s easy for anyone to set up a restaurant.
Characteristics
- Many small firms
- Low barriers to entry
- Products are slightly differentiated
- Perfect knowledge
- Price makers
Monopolistic firms are price makers due to their differentiated products. Monopolistic firms have a downward sloping demand curves (AR & MR) due to their price setting abilities.
A Monopolistic firm makes supernormal profits in the short run when it’s the first firm in the market.
However due to low barriers to entry and attraction to the supernormal profits. Competitive firms will also enter increasing the supply of firms producing the same product. This will lead to a decrease in demand for the initial firm dominating the market and a reduction in it’s profits. Therefore firms in a monopolistic market will make normal profits in the long run.
Advantages of Monopolistic Competition
- Firms operate at P > MC, hence they are allocatively efficient in the short and long run
- Consumers have access to a greater variety of products
- Compared to perfect competition, the model of Monopolistic Competition is more realistic
- In the short run, firms are able to produce supernormal profits which may increase dynamic efficiency
Disadvantages of Monopolistic Competition
- Firms struggle to produce supernormal profits in the long run, limiting their dynamic efficiency
- Firms experience x-inefficency as they have little incentive to minimise their costs
Quick Fire Quiz – Knowledge Check
1. Identify all the characteristics of monopolistic competition (4 marks)
2. Explain the difference between Perfect Competition and Monopolistic Competition (4 marks)
3. Draw a short run monopolistic diagram (4 marks)
4. Draw a long run monopolistic diagram (4 marks)
5. Discuss whether firms are productively or allocatively efficient in a monopolistic competition (4 marks)
6. Identify two examples of Monopolistic competition (2 marks)
Next Revision Topics:
A Level Economics Past Papers
