Read this chapter to learn about monopolistic competition. Make sure to distinguish the short-run from the long-run model.
Monopolistic competition is a type of imperfect competition such that many producers sell products that are differentiated from one another.
Evaluate the characteristics and outcomes of markets with imperfect competition
Monopolistic competition is a type of imperfect competition such that many producers sell products that are differentiated from one another as goods but not perfect substitutes (such as from branding, quality, or location). In monopolistic competition,
a firm takes the prices charged by its rivals as given and ignores the impact of its own prices on the prices of other firms.
Unlike in perfect competition, firms that are monopolistically competitive maintain spare capacity. Models of monopolistic competition are often used to model industries. Textbook examples of industries with market structures similar to monopolistic competition include restaurants, cereal, clothing, shoes, and service industries in large cities.
Clothing: The clothing industry is monopolistically competitive because firms have differentiated products and market power.
Monopolistic competition is different from a monopoly. A monopoly exists when a person or entity is the exclusive supplier of a good or service in a market. The demand is inelastic and the market is inefficient.
Monopolistic competitive markets:
Markets that have monopolistic competition are inefficient for two reasons. The first source of inefficiency is due to the fact that at its optimum output, the firm charges a price that exceeds marginal costs. The monopolistic competitive firm maximizes
profits where marginal revenue equals marginal cost. A monopolistic competitive firm's demand curve is downward sloping, which means it will charge a price that exceeds marginal costs. The market power possessed by a monopolistic competitive firm
means that at its profit maximizing level of production there will be a net loss of consumer and producer surplus.
The second source of inefficiency is the fact that these firms operate with excess capacity. The firm's profit maximizing output is less than the output associated with minimum average cost. All firms, regardless of the type of market it operates in, will produce to a point where demand or price equals average cost. In a perfectly competitive market, this occurs where the perfectly elastic demand curve equals minimum average cost. In a monopolistic competitive market, the demand curve is downward sloping. In the long run, this leads to excess capacity.
Source: Lumen Learning, https://courses.lumenlearning.com/boundless-economics/chapter/monopolistic-competition/
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