16
Monopolistic Competition
 relatively small economies of scale
 many firms
 product differentiation
 close but not perfect substitutes
 product characteristics, location,
services offered, product image
 no artificial barriers to entry
Demand and Costs
 As new firms enter, demand curve for each
firm shifts to the left.
Cost or Revenue ($)
4.00
Demand
3.50
(each of 2 firms)
3.00
2.50
2.00
Demand
1.50
(each of 4 firms)
1.00
0.50
Demand
Assuming that all firms
(each of 8 firms)
100
200
charge the same price
300
share the market.
400 and
500
Output
 Economies of scale reduce average total
cost (ATC) for larger levels of production.
Cost or Revenue ($)
4.00
3.50
3.00
2.50 ATC
2.00
1.50
1.00
0.50
MC
100
200
300
400 500
Output
Market with 2 Firms
Demand
Cost or Revenue ($)
4.00
M
(2 firms)
R
3.50
Quantity = 400
Price = $2.50
Ave. Cost = $1.38
3.00 ATC
2.50
2.00
$1.12
$448 profit
400 units
1.50
1.00
0.50
MC
100
200
300
400 500
Output
Cost or Revenue ($)
Market with 4 Firms
4.00
M
Demand
R
3.50
(4 firms)
Quantity = 200
Price = $2.50
Ave. Cost = $1.75
3.00
2.50
$150
$0.75
2.00
200 units
1.50
ATC
1.00
0.50
MC
100
200
300
400 500
Output
Each firm has a share of
the market
Market with 8 Firms
 New firms enter as long as there are profits.
Cost or Revenue ($)
4.00
M
Demand
Quantity = 100
Price = $2.50
Ave. Cost = $2.50
(8 firms)
R
3.50
3.00
2.50
2.00
ATC
1.50
1.00
average cost
is higher
MC
0.50
100
200
300
400 500
Output
Monopolistic Competition vs. Perfect Competition
Cost or Price ($)
40
35
MC
Average
total cost
30
25
20
15
MR
10
5
Because
MR = Demand …
2
4
6
… at equilibrium
MC = AC
=
Demand
8
10
Output
Monopolistic Competition vs. Perfect Competition
40
Average
total cost
Cost or Price ($)
Demand
35
MC
30
25
MR
20
15
10
5
2
4
Because
MR < Demand …
6
8
10
… at equilibrium
Output
MC < AC