Micro CHAPTER 4.4:

CHAPTER SUMMARY

Monopolistic competition is a market structure with:

• Many sellers

• Low barriers to entry

• The ability for producers to differentiate their product from competitors & non-price competition

Some examples of monopolistic competition include restaurants, clothing stores, and barbers/salons. As a result of the unique features of this market structure, monopolistically competitive markets...

• Allow firms to be price-makers (to an extent)

• Result in inefficient use of resources, long-run break-even for firms, and long-run excess capacity

The basic graph of a monopolistically competitive firm looks and functions the same as the graph of a monopolistic firm, assuming neither one can price discriminate.

One reason that monopolistic competition is different from monopoly, though, is that if one firm is profitable, because barriers to entry are lower, other firms will see this and be encouraged to enter the market. Demand for the entire market will stay the same, but with more firms, each individual firm will see less demand, shifting the demand curve for each individual firm to the left. In the long-run, this will result in all firms earning a normal profit. You can see in the second chart, which I have drawn beautifully over the first one, that a shift in demand results in a profit maximization point where ATC = D, so the firm would earn a normal profit.

In the long-run, monopolistically competitive firms will also experience excess capacity, meaning that they are producing at an inefficient level. The most efficient level of production would be at the lowest point of ATC, but they instead produce at the quantity where MC = MR, which is lower in the long-run. The difference between these two quantities is the excess capacity.

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