characteristics of monopolistic competition:
There are many buyers and sellers in the market place, none of
whom are large enough to influence the price. Sellers are described as being price takers.
There is freedom of entry and exit into the market, i.e.,
barriers to entry are low. Firms must be able to establish themselves quickly
in the marketplace.
Buyers and sellers have perfect knowledge, economic agents are
fully informed of prices and output in the industry.
Firms produce a non-homogeneous (differentiated) product.
It can be
seen that the characteristics are the as perfect competition, except
monopolistic firms produce a non-homogeneous product.
produce a differentiated product, they will have a certain amount of market
power due to brand loyalty. Firms are therefore not price takers, as they can
raise prices without losing all of their customers. The demand curve will be
downward sloping, but relatively elastic due to the number of close
possible that a firm operating in monopolistic competition could earn
abnormal profits, normal profits or make a loss.
Abnormal profits (AR>AC)
Normal profits (AR=AC)
Losses (AR less than AC).
absence of barriers to entry allows firms to enter the industry, this will
occur if abnormal profits are being earned. The entry of new firms will shift
the demand curve for any particular firm to the left, as consumers demand
moves from one firm to another. The demand curve will continue to shift to
the left until it is tangential to the average cost curve (AR=AC), where
normal profits are earned and there is no incentive for further firms to
enter the industry.
This is a
rather complicated diagram, I have found the following is the best way of
Draw a relatively inelastic demand / average revenue curve and
marginal revenue curve (remember the demand curve should be elastic).
Draw the average cost curve, with its point of tangency towards
the top of the average revenue curve.
Label the price and quantity at the point of tangency.
- Now draw the
marginal cost curve, it is essential that it cuts the marginal revenue at
the quantity label in the previous step. The marginal cost curve must also
intersect the average cost at its minimum.
Monopolistic Competition PowerPoint Model
Monopolistic Competition PowerPoint Presentation
Monopolistic Competition Worksheet