define monopolistic competition
an industry where there are many firms oftern with minimal product differenciation
what are the charactertistics of monoploistic competition?
(6)
- many buyers and sellers
- slight product differencaiation
- imperfect knowledge
- small barriers to enter/exit
- little price making power but AR and MR are still downwards sloping
- long run normal profit
what are the differences of monopolistic competition vs perfect competition?
- (minimal) product differenciation (XED is high and PED is elastic cos sm subsutitutes)
- (minimal) price making power- downwards sloping AR and MR
what are examples of product differenciation?
non price competition
- quality of product: quality of ingrediants
- customer service and after care of product: eg replacement of parts after purchase
- branding
- product performance: reliability and speed
what are some good real life examples of monopolistic competition?
- bakeries/ cafes
- chicken shops
- hairdresser
draw short run equilibrium diagram of monopolistic competion
draw and explain long run equilibrium of monopolistic competition
+ analysis
- since there are little barriers to exit/ enter the market in long run
- supernormal profits made in short run attract new supliers offereing new differenciated products
- as more firms enter the market, the demand curve (AR - and MR ) for any existing firm shifts to the left (market saturation)
- at long run equilibrium, the firm is at the profit maximising level of output by only making normal profit
is monopolistic competition efficent?
- allocative: not really coz price !=MC, but it is closer
- productive: no becuase high market saturation means that no one benefits from economices of scale, not on MES of LRAC
- dynamic: yes because very intense non price competition (product differenciation) so lots of innovation, but no supernormal profit so lack of investment into research and development
- X ineffiencies: less likley due to intense competition
how does monopolistic competition affect consumers?
3 points+ eval
- low barriers to entry mean that there is intense (non price) competition between firms, leading to more choice and better quality.
EV: more choice in not always beneficial as people have bounded rationality and may not make optimal decisions if there is a bewildering choice - prices are kept close to marginal cost, leading to improved allocative efficency
EV: high market saturation means that firm are no able to exploit economies of scale, so are not operating on MES of LRAC curve, so loss of productive efficency - high level of innovation due to intense non price competition, so improvement in dynamic effiency.
EV: lack of supernormal in long run, so lack of investment into research and development, limiting scope of dyamic efficency. Product differenciation through excessive packaging leads to increased wastage and external costs from plastic.
” Assess the extent to which monoplistic competition leads to economic efficency”
Exam Question (1 KAA+ 1EV+ diagram)
KAA:
* In monopolistic competition, we assume that there are many firms each selling slightly differentiated products and the barriers to entry are low.
* An example may be sandwich shops competing in a city centre.
* Intense competition between suppliers means that demand is likley to be price elastic (PED>1), which then means that prices may move closer to marginal cost.
* Therefore, in contrast to a monopoly, prices for consumers will be lower and this would be an improvement in allocative efficiency of scarce resources.
EV:
* However, firms in monopolistic competiton still have some scope of pricing power, hence why AR and MR are downwards sloping.
* This is especially true for firms with strong brand loyalty.
* Even if the entry of new products and firms means that normal profits are made in the long run, price will remain above MC, so allocative efficency is not achieved.
* The saturation of many differenciated products in monopolistic competition may also lead to a loss of productive efficency as firms are unable to fully exploit economic of scale in the long run.
