ECON10004 Lecture Notes - Lecture 7: Market Power, Imperfect Competition, Demand Curve
Microeconomics Week 7
CHAPTER 16: MONOPOLISTIC COMPETITION
Between Monopoly and Perfect Competition
• Competition occurs when there are many firms offering essentially identical
products
• Monopoly occurs when there is only one firm in the market
• Many markets have these elements but are not 100% of either
• Typical firm faces competition, but often not so rigorous so as to be price-takers
• Typical firm has some market power, but not enough to make a monopoly
• Many industries fall somewhere between perfect competition and monopoly:
imperfect competition, two types:
o Oligopoly, eg. Coles and Woolworths
o Monopolistic Competition
Oligopoly: a market structure in which only a few sellers offer similar or identical products
Monopolistic Competition: a market structure in which many firms sell products that are
similar but not identical
• Each firm has monopoly over the product it makes, but many other firms make
similar products that compete for the same customers
• Many Sellers
• Product Differentiation: products slightly differ; rather than being price taker, each
firm faces downward-sloping demand curve
• Free Entry: in long run, firms can enter/exit market without restriction
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COMPETITION WITH DIFFERENTIATED PRODUCTS
The Monopolistically Competitive Firm in the Short Run
• Each firm in a monopolistically competitive market is in many ways like a monopoly
• Products are different from other firms ∴ downward-sloping demand curve
• Moopolistiall opetitie fir follos oopolist’s rule for profit aiisatio
o Choose the quantity at which marginal revenue = marginal cost and uses
demand curve to find price consistent with that quantity
The Long-Run Equilibrium
• When firms are making profits, new firms have incentives to enter the market
• Increases # of products and reduced demand faced by each firm already in market
(shifts demand curve to left)
• As demand decreases, profit declines
• When making losses, firms exit, demand shifts right
• Process of entry and exit continues until firms in market are making exactly zero
economic profit
• Once market reaches this new equilibrium, new firms have no incentive to enter and
existing firms have no incentive to exit
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• Demand curve just barely touches ATC curve; tangent to each other
• Must be tangent once entry and exit driven profit to zero
• Tangent occurs at same quantity where MR = MC
o This is required because this particular quantity maximises profit and is
exactly zero in long run
Two characteristics describe the long-run equilibrium in a monopolistically competitive
market:
1. Price exceeds marginal cost, this conclusion arises because profit maximisation
requires MR = MC and because downward sloping demand curve makes MR less
than price
2. Price equals average total cost, this conclusion arises because free entry and exit
drive economic profit to zero
Monopolistic versus Perfect Competition
Excess Capacity
• Exit and entry drive each firm to a point of tangency between demand and ATC
curves
• Quantity of output at this point is smaller than quantity that minimises ATC
• ∴ in monopolistic competition, firms produce on the downward-sloping portion of
ATC curves
• Quantity that minimises ATC is the efficient scale of firm, in long run perfectly
competitive firms produce at efficient scale while monopolistically competitive firms
produce below this level
• Firms said to have excess capacity under monopolistic competition
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