Chapter+17+Monopolistic+Competition+kc



How does a firm make decisions in a Monopolistic Competition?

Last chapter we talked about Oligopoly, which was a type of market structure between monopoly and competition. Another market structure that belongs somewhere in between the two is called Monopolistic Competition. Monopolistic competition is like a competitive market because there are numerous sellers in the market. However, it also has the characteristics of a monopoly because they offer differentiated products. These two key characteristics of a monopolistic competition- having many sellers and producing differentiated products- make the decisions of a Monopolistic Competition unique. In this chapter, we’ll be going into some details on their decision making methods.

**Monopolistic Competition in the SHORT RUN** Let’s first start out with a graph of a monopolistically competitive market.

(a) when the firm makes profit (b) when the firm makes losses

Just as you see above, the graph of a monopolistically competitive market is very similar to a monopoly. It first has the demand curve sloping downwards, the marginal revenue below it, and the marginal cost (supply) curve sloping up. The firm produces at its profit maximizing quantity which is where marginal revenue and marginal cost intersect. For this profit maximizing quantity, firms experience one of the two outcomes.  When firms make profit, this induces entry of other firms. This then shifts the demand curves to the left, which decreases profit. When firms make losses on the other hand, it induces firms to exit the market. This would shift the demand curve to the right, and which decreases profit. This process continues until the firms reach equilibrium where no profit nor losses can be made.
 * Price is greater than ATC, and the firm achieves profit
 * Price is less than ATC, and the firm faces losses, so they must try and minimize the losses
 * Monopolistic Competition in the LONG RUN**

Let’s now compare monopolistic competition and perfect competition. In a perfect competition, firms produce at the efficient scale (the place where marginal cost equals marginal revenue). Monopolistic firms differ and they produce below this scale. Therefore the property of excess capacity explains that an increase in the production quantity will lead monopolistically competitive firms to produce at a lower ATC.
 * Monopolistic vs. Perfect Competition**

Whereas in perfectly competitive firms the MR=P, in monopolistically competitive firms MR<P. The MR curve for monopolistically competitive markets are sloping down because each individual firms have an impact on the overall price of the market. Since in the long term equilibrium, monopolistically competitive firms produce along the downward slope segment of the ATC curve, which means that the marginal cost will always be below ATC. This is why monopolistically competitive firms earn more profit from selling an extra unit than perfectly competitive markets.

Label if the following is a property of Monopolistic Competition or not a property of Monopolistic Competition P > MC YES  P = MR NO  Many Firms YES  Price taker NO  Efficiency NO <span style="font-family: Verdana,Geneva,sans-serif; font-size: 120%;"> differentiated products <span style="color: #ffffff; font-family: Verdana,Geneva,sans-serif; font-size: 120%;">YES (highlight the above to see answers)

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 * monopolistic competition**- market structure where many firms sell similar but differentiated products
 * excess capacity**- a firm can possibly produe more and lower the ATC of production