Market Structures: Monopolistic
Competition
Imperfect Competition
• The spectrum of competition:
Perfect Comp. ------------- Monopoly
Monop. Comp.-- Oligopoly
• Assumptions underlying Monopolistic
Competition
– Differentiated products
• Differentiated products leads to some market power over price
or a downward slping demand curve
– Many buyers and sellers
– Free entry and exit
– Perfect knowledge
Short-run Vs. Long-run Supply
Decisions
• In the short-run, the firm is able to set prices like a
monopolistic. P>MR so MR=MC implies that
P>MC. A firm can make profits, breakeven or
make losses.
• In the long-run, free entry and exit will eliminate
economic profits or losses.
• In either case, the monopolistically competitive
firm produces a level of output where LRAC are
greater than LRAC minimum or the efficient scale
and sets price above MC.
Monopoly Competition and
Economic Welfare
• Compared to competitive markets, monopolistic
competition results in an output level where there
is
– Excess capacity – LRAC >LRAC min
– P>MC - or MB>MC
– So, Deadweight Welfare Loss exists
• Welfare loss is due to product differentiation
– If differentiation is real, the welfare is small
– If differentiation is the result of advertising which does
not contribute anything to consumer satisfaction, it
represents welfare loss
Advertising
• Advertising is costly, the question is - does it add
anything of value to the consumer?
– informative advertising which contributes to
competition
– Advertising aimed at creating perceived differences or
brand loyalty
– Breakfast cereals and kids versus supermarket ads
• Advertising and the prisoner’s dilemma – selfcanceling ads.