Monopolistic Competition

Monopolistic Competition

1. large number of firms

   • small market power => price setter

2. differentiated products

   • have real and imaginary differences => close but imperfect subs of each other => relatively price elastic

3. low BTE (in the LR)

   • only earns normal profits in LR

4. prevalence of non-price competition

   • advertisements
   • product development
   • -increase DD for firms' product => stresses specific qualities. -increases costs => if revenue able to cover development and promo costs => improved profit position

5. maximising profits (MC = MR)

   • SR
     • supernormal (TR > TC)
     • normal (TR = TC)
     • subnormal (TR < TC)
   • LR
     • only earns normal profits (theoretical)
       • if earning superN profits
         • new firms enter => DD curve shifts left and becomes more price elastic => continues to enter until DD curve shifts until it's tangent to AC curve => normal profits
       • if earning subnormal profits
         • existing firms exit => DD curve shifts right and becomes more price inelastic => continues to leave until DD curve shifts until it's tangent to AC curve => normal profits

6. efficiency

   • allocatively inefficient (P > MC) => have DWL
   • productively efficient (produces at lowest cost)

7. impacts

   • consumers
     • +ve: price charged is just enough for firm to stay in production; more variety. -ve: lack ability to innovate; mislead consumers; prices are higher than what they could be; consumer surplus not maximised
   • producers
     • +ve: firms can enter profitable industry. -ve: only earning normal profits; normal profits not given though, has to continuously keep differentiating and keep costs low in LR
   • society
     • +ve: welfare maxi firms choose to produce at P =MC. -ve: profit and revenue maxi firms produce at P > MC => allocatively inefficient; profit maxi firms do not produce at lowest point of LRAC; non- price competition leads to wastage of resources
   • govt
     • +ve: labour intensive firms help lower unN rate. -ve: govt needs to intervene to manage false advertising; needs to assist with innovation incentives

8. limitations of theory

   • imperfect knowledge in MC
   • if they continue to make use of its differentiated product => could earn superN profits in LR
   • practically impossible to derive market DD curve