Monopolistic Competition

Monopolistic Competition: Overview

  • Monopolistic Competition refers to a market structure where a large number of firms produce differentiated products and have some market power to set prices.
  • It does not have the high barriers to entry that a pure monopoly has, allowing for both competition and individual control over pricing.

Characteristics

  • Large number of buyers and sellers: There are many sellers providing the market with products, and no single seller can control the market price.
  • Product Differentiation: Every firms tries to differentiate their product from those of rivals, whether through actual differences, branding, advertising or other means.
  • Freedom of Entry or Exit: Firms are free to enter or leave the market, meaning that supernormal profits can only be made in the short run.
  • Non-price Competition: Firms often compete through means other than pricing, such as advertising, branding, and quality.

Short Run and Long Run Equilibrium

  • Short Run: Firms can make abnormal profits or losses in the short run. As they have some market power, they can influence price to exceed marginal cost.
  • Long Run: In the long run, the movement of firms, attracted by supernormal profit or deterred by losses, erodes any supernormal profit. Firms will earn just normal profit, meaning price equals average cost.

Efficiency

  • Monopolistic competition results in productive inefficiency as firms do not produce at the lowest point on the average cost curve.
  • It also leads to allocative inefficiency since price is higher than marginal cost.
  • It may increase dynamic efficiency due to innovation encouraged by non-price competition.
  • There is also X-inefficiency as firms are not under pressure to minimise costs.

Advantages and Disadvantages

  • Advantages: Diversity and choice for consumers, potential for innovation and more information available due to non-price competition.
  • Disadvantages: Allocative and productive inefficiency, possibility of too much choice leading to consumer confusion, and increased costs due to advertising and branding.

Relevance to the Real World

  • Many industries are best described as monopolistically competitive, including restaurants, clothing, and consumer electronics. Therefore, understanding it can provide valuable insight into these key industries.