Introduction :The monopolistic competition is a

combination of monopoly and perfect

competition. It is a type of imperfect
competition.
It is developed by Mrs. Joan
Robinson .

Definition :The monopolistic competition means that

of market situation in which many
sellers sells differentiated products
which are close substitutes to large
number of buyers at different prices.
For example:-garment industry, cosmetic
products, furniture, restaurants.

Characteristic of monopolistic
competition :* Many sellers
There are many firms competing for the same
group of customers.

* Product differentiation
This is on of the most Important characteristic
of this type of market .
Product is slightly different from other firms.
Each firm faces downward sloping demand
curve.

* Free entry & exit

* Selling cost
-firm has to spend a lot on the
advertisement of its products
so the price of the product is
high

* Close substitutes.
-This are the goods which can
be consumed in place of one
another
for example, tea & coffee

(a) Firm Makes Profit

Price
MC
ATC

Average
total cost

Demand

Profit
MR

Quantity

(b) Firm Makes Losses

Price
MC
Losses

ATC

Average
total cost
Price

MR
0

Lossminimizing
quantity

Demand
Quantity

In 1st diagram, demand and

marginal revenue curves for two typically
firms, each in a different monopolistically
competitive industry. In both panels of this
figure, the profit maximizing qty is found at
the intersection of the marginal revenue and
marginal cost curves. The two panels in this
figure show different outcomes for the firms
profit. In panel (a) price exceeds average total
cost, so the firm makes a profit. In panel (b),
price is below average total cost. In this case,
the firm is unable to make a positive profit, so
the best the firm can do is to minimize its
losses.

Monopolistic competitors in the short

run
Monopolistic competitors, like
monopolists, maximizing profit by producing the
quality at which marginal revenue equals marginal
cost. The firm in panel (a) makes losses because, at
this qty, price is above avg total cost. The panel (b)
makes losses because, at this qty, price is less than
avg total cost.

All this should seem

familiar. A monopolistically competitive
firm chooses its qty and price just as a
monopoly does. In the short run, these
two types of market structure are similar.

When firms making profits, as in panel (a),

new firms have an incentives to enter the market. This
entry increases the number of products from which
customers can choose & therefore, reduce the demand
faced by each firm already in the market. In other words
profit encourages entry, entry shift the demand curves
faced by the incumbent firms products fall, these firm s
experience declining profit.
In other words losses encourage exit, and exit
shifts the demand curves of the remaining firms to the
right. As the demand for the remaining firms products
rises, these firms experience rising profit (that is
declining losses).

The process of entry and exit

continues until the firms in the market are
making exactly zero economic profit. In this
diagram, once the market reaches this
equilibrium, new firms have no incentive to
enter & existing firms have no incentives to exit.

Price
MC
ATC

P =ATC

MR
0

Profit-maximizing
quantity

Demand
Quantity

in a monopolistically competitive
market, if firms are making profit, new firms enter,
and the demand curves for the incumbent firms
shift to the left. Similarly if firms are making losses,
old firms exit, and the demand curves of the
remaining firms shift to the right. Because of these
shifts in demand, a monopolistically competitive
firm eventually finds itself in the long run
equilibrium shown here. In this long run
equilibrium, price equals ATC & the firms earns zero
profit.

Notice that the demand

curve in this figure just barely touches the ATC
curve. Mathematically, we say the two curves are
tangent once entry and exit have driven profit or
zero. Because profit per unit sold is the difference
between price and ATC, the maximizing profit is zero
only if these two curves touch each other without
crossing.
Characteristic of long run
as in a monopoly market, price exceeds MC . This
conclusion arises because profit maximizing requires
marginal revenue to equal marginal cost and
because the downward slopping demand curve
makes marginal revenue less than the price.
As in a competitive market, price equals ATC. This
conclusion arises because free entry and exit drive
economics profit or zero.

The second characteristic shows how

monopolistic competition differs from monopoly.
Because a monopoly is the sole seller of a product
without close substitutes, it can earn positive economic
profit even in the long run. By contrast, because there
is free entry into a monopolistically competitive
market, the economic profit of a firm in this type of
market is driven to zero.

Monopolistic versus Perfect

Competition
Excess

Capacity

There is no excess capacity in perfect

competition in the long run.
Free entry results in competitive firms
producing at the point where average
total cost is minimized, which is the
efficient scale of the firm.
There is excess capacity in monopolistic
competition in the long run.
In monopolistic competition, output is
less than the efficient scale of perfect
competition.

Figure 3 Monopolistic versus Perfect Competition

(a) Monopolistically Competitive Firm

Price

(b) Perfectly Competitive Firm

Price

MC

MC

ATC

ATC

P
P = MC

MR

Quantity
produced

Efficient
scale

P = MR
(demand
curve)

Demand

Quantity

Quantity produced =
Efficient scale

Quantity

Copyright2003 Southwestern/Thomson Learning

Monopolistic versus Perfect

Competition
There are two noteworthy
differences between monopolistic
and perfect competitionexcess
capacity and markup.

Monopolistic versus Perfect

Competition
Markup Over Marginal Cost
For a competitive firm, price equals
marginal cost.
For a monopolistically competitive
firm, price exceeds marginal cost.
Because price exceeds marginal
cost, an extra unit sold at the posted
price means more profit for the
monopolistically competitive firm.

Figure 3 Monopolistic versus Perfect Competition

(a) Monopolistically Competitive Firm

Price

(b) Perfectly Competitive Firm

Price

MC

MC

ATC

ATC

Markup

P
P = MC

P = MR
(demand
curve)

Marginal
cost
MR

Quantity
produced

Demand

Quantity

Quantity produced

Quantity

Copyright2003 Southwestern/Thomson Learning

Figure 3 Monopolistic versus Perfect Competition

(a) Monopolistically Competitive Firm

Price

(b) Perfectly Competitive Firm

Price

MC

MC

ATC

ATC

Markup

P
P = MC

P = MR
(demand
curve)

Marginal
cost
MR

Quantity
produced

Efficient
scale

Demand

Quantity

Quantity produced =
Efficient scale

Quantity

Excess capacity

Copyright2003 Southwestern/Thomson Learning

Monopolistic Competition
and the Welfare of Society
Monopolistic competition does
not have all the desirable
properties of perfect competition.

Monopolistic Competition
and the Welfare of Society
There

is the normal deadweight

loss of monopoly pricing in
monopolistic competition caused
by the markup of price over
marginal cost.
However, the administrative
burden of regulating the pricing of
all firms that produce differentiated
products would be overwhelming.

Monopolistic Competition
and the Welfare of Society
Another way in which
monopolistic competition may be
socially inefficient is that the
number of firms in the market
may not be the ideal one.
There may be too much or too
little entry.

Monopolistic Competition
and the Welfare of Society
Externalities of entry include:
product-variety externalities:
business-stealing externalities:

Monopolistic Competition
and the Welfare of Society
The

product-variety externality:

Because consumers get some consumer

surplus from the introduction of a new
product, entry of a new firm conveys a
positive externality on consumers.
The

business-stealing externality:

Because other firms lose customers and

profits from the entry of a new
competitor, entry of a new firm imposes
a negative externality on existing firms.

ADVERTISING
Whether

you are reading a pamplets

newspaper ,waching t.v ,or driving
down the highway some firm will try
to convince you to buy its product.
When firem sell differentiated
products and chage prices above
marginal cost,each firm has an
incentive to advirtise in order to
attract more buyers to its particular
product

ADVERTISING
Innovation and Product
Development

Wherever economic profits are

earned, imitators emerge.
To maintain economic profit, a firm
must seek out new products.
Cost Versus Benefit of Product
Innovation
The firm must balance the cost and
benefit at the margin.

ADVERTISIN
Efficiency andG
Product Innovation

Regardless of whether a product

improvement is real or imagined, its
value to the consumer is its marginal
benefit, which equals the amount the
consumer is willing to pay.
The marginal benefit to the producer is
the marginal revenue, which in
equilibrium equals marginal cost.
Because price exceeds marginal cost,
product improvement is not pushed to
its efficient level.

ADVERTISING
Advertising

Firms in monopolistic competition spend a large

amount on advertising and packaging their
products.
Marketing Expenditures
A large proportion of the prices that we pay
cover the cost of selling a good.
Figure 15.5 on the next slide shows some
estimates of marketing expenditures for some
familiar markets.

ADVERTISING
Selling Costs and Total Costs
Advertising expenditures increase the
costs of a monopolistically competitive
firm above those of a perfectly
competitive firm or a monopoly.
Advertising costs are fixed costs.
Advertising costs per unit decrease as
production increases.
Figure 15.6 on the next slide illustrates
the effects of selling costs on total cost.

ADVERTISING
Selling Costs and Demand
Advertising and other selling efforts
change the demand for a firms product.
The effects are complex:
A firms own advertising increases the
demand for its product
Advertising by all firms might decrease the
demand for any one firms product .

ADVERTISING
Using

Advertising to Signal Quality

Some advertising is very costly and has almost no

information content about the item being
advertised.
Such advertising is used to signal high quality.
A signal is an action taken by an informed
person or firm to send a message to uninformed
people.
Signaling works because it is profitable to signal
high quality and deliver it but unprofitable to
signal a high quality product and not deliver it.

ADVERTISING
Brand

Names

Brand names are also used to provide

information about the quality of a product.
It is costly to establish a widely recognized
brand name.
Like costly advertising, a brand name signals

high quality.
Brand names work because it is unprofitable to
incur the cost of creating a brand name and
then deliver a low quality product.

ADVERTISING
Efficiency

of Advertising and Brand

Names
Advertising and brand names that provide
information about the quality of products
so that buyers are able to make better
choices can be efficient if the marginal
cost of the information equals its marginal
benefit.
The final verdict on the efficiency of
monopolistic competition is ambiguous.