In this video we’ll learn about monopolistic competition.
We’ll focus on the characteristics of monopolistic competition first and then take a look at
the long-run diagram.
I’ve timestamped the video in the description if you want to jump ahead to the diagram.
Let’s now consider the specific characteristics of this market structure.
Monopolistic competition falls under the category of imperfect competition.
This is because the products in a monopolistically competitive market are slightly differentiated.
They can differ by brand, size, quality, design or other distinguishing features.
A great example of this would be the market for dishwashing liquid.
There are many different brands to choose from and they are all slightly different.
Firms also produce different quality dishwashing soap.
Some differences are perceived by consumers while others are genuine.
Preference for one or the other can influence a consumer’s buying decision so the producer
has some market power, but not much.
If they decide to increase price by a significant amount, consumers would simply switch to other
similar, but more affordable brands.
This is mostly because consumers are aware of the similarity between the products and
would likely be reluctant to pay significantly more for a product they deem can serve the
same function.
As mentioned earlier, there are a large number of buyers.
However, also as mentioned before, the sellers actually do have some market power due to
the nature of the product.
It is not much, as consumers have many similar alternatives to choose from.
On the other side, there are many sellers.
They can exert some market power due to the differentiation of their product.
It’s important to note that due to the large number of competitors in the market it is
impossible for them to collude and manipulate prices and output.
Firms try to strengthen their market position in the eyes of consumer through advertising
and developing brand loyalty.
This would result in greater demand and possibly more inelastic demand for their product.
In monopolistically competitive markets, some firms are able to gain a competitive edge
because perfect information does not exist.
They may be able to establish that edge by improving their products or production methods,
and this information is not accessible by competing firms.
Firms are able to exploit this advantage and achieve supernormal profits in the short-run.
Consumers also do not have perfect knowledge or full awareness about the offerings, prices
and quality of all the existing products available.
There are also very low barriers to entry or exit which means that firms can enter and
exit the market and face low costs or restrictions.
The industry is completely open to new entrants.
This also means a firm earning supernormal profits in the short-run cannot maintain them
in the long-run.
Now let’s get to the diagram.
This is usually the source of a lot of confusion for economics students so I’ll break it
down into small steps and try to help you understand it that way.
If you have questions at any point, write them in the comments and I will do my best
to answer.
The demand curve for the monopolistically competitive firm is downward sloping due to
their ability to set price.
Since their product is somewhat unique, they can raise or lower their price to sell more
or less of a product.
They are not forced to accept the market price as is the case in perfect competition.
Their marginal revenue curve is twice as steep as the demand curve.
If we include average cost and marginal cost curves for the firm, we should have all the
information we need to determine the profit-maximising level of output and price.
Once again, we find the intersection of MR and MC and drop down to find our profit maximising
quantity.
We follow this quantity up to the demand curve to find our price.
This allows us to determine our total revenue and total costs.
In this case they are equal to each other and we can see that the monopolistically competitive
firm can only make normal profit in the long-run.
Since the firm is not selling at a price equal to its marginal cost it is not allocatively
efficient.
Nor is it productively efficient because it is producing at an average cost above its
lowest possible average cost.
In the next video on monopolistic competition we’ll see how firms in this type of market
structure can earn supernormal profits in the short-run.
Hopefully you’re more familiar with monopolistic competition now and understand the key characteristics
of the structure.
Practice the diagram on your own and you will start to get more comfortable with it.
If you have any questions or comments, leave them below and I’ll try to get back to you.
That’s us done for now and I will see you in the next one!