Monopolistic+Competition

Watch these videos in preparation for the lesson: media type="youtube" key="AQLn5CCAm9o" width="560" height="315" media type="youtube" key="yQBsgxz_ERA" width="560" height="315"

Monopolistically competitive markets have the following characteristics: In other words the characteristics of a monopolistically competitive market are almost the same as in perfect competition, with the exception of monopolistic competition having heterogeneous products, and that monopolistic competition involves a great deal of non-price competition (based on subtle product differentiation such as branding).Because of brand loyalty, it can raise its prices without losing all of its customers. This means that an individual firm's demand curve is downward sloping, in contrast to perfect competition, which has a [|perfectly elastic] demand schedule. A firm making profits in the short run will [|break even] in the long run because demand will decrease as new firms attracted by abnormal profits enter the industry. This means in the long run, a monopolistically competitive firm will make normal profits.  Here is a possible short run equilibrium with the firm making abnormal profits.  Here is the long run equilibrium where the firm is making just normal profits
 * There are many producers and many consumers in a given market, and no business has total control over the market price.
 * Consumers perceive that there are non-price differences among the competitors' products, in that products are similar, but not identical.
 * There are no [|barriers to entry] and exit.
 * Producers have a degree of control over price.

It is sufficient to explain that the abnormal profits are competed away, by the new entrants, that are attracted by the SR abnormal profits. The new entrants take customers away from the existing firms so the firms that were making the abnormal profits see Demand for their products fall, until they are once again only making normal profits. Diagrammatically this is shown by a shift of the AR and MR curves to the left until the AR curve is tangential to the AC curve. But it is surprisingly difficult to draw and the IBDP doesn't require you to draw it. But that shouldn't stop us from doing so! media type="custom" key="22420958"

And that is about it. If you are still unsure about this topic here is a video which explains the basics again <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">media type="file" key="Episode 29_ Monopolistic Competition.mp4" width="613" height="613"

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Points to remember: <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Whilst monopolistic competition is both productively and allocatively inefficient, this is merely due to the price making ability of the firms when compared to perfect competition. It is hard to be critical of firms for this when really they are differentiating their products and providing consumers with choice. Remember they do not have the ability to abuse their power to raise prices too much, nor can they make abnormal profits in the long run. Firms in monopolistic competition are probably dynamically efficient as they are in a highly competitive market.

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Evaluation of Monopolistic Competition – Advantages:


 * <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Differentiated products – this means more choice for consumers
 * <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Firms have incentives to innovate – higher and improving quality of products, looking formore efficient ways of production, possibly leading to a lower prices
 * <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Advertising – usually there is a high level of advertising in monopolistic competition; this provides consumers with information and hence, lowers search costs
 * <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Creates employment in marketing (a rather far stretched advantage, mention only briefly)

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Evaluation of Monopolistic Competition – Disadvantages:


 * <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Neither technically nor allocatively efficient – this leads to deadweight welfare loss – the primary economic problem of allocating resources in the most efficient way is not solved
 * <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Resources are wasted on e.g. useless packaging
 * <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Large number of firms – that means limited access to Economies of Scale
 * <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Large number of firms – could lead to too much choice for consumers and in turn tohigher search costs
 * <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Advertising – might mislead consumers
 * <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Advertising is usually costly, hence, product prices might be higher
 * <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">No abnormal profits limited innovation and investment in R&D

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Monopolistic Competition – Examples:


 * <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Restaurants/Bars/Pubs (fast food restaurants/chains can usually be oligopolies rather than monopolistic competition)
 * <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Hotel businesses
 * <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">The market for chocolate chip cookies (might be that some countries are dominated by certain firms)