Monopolistic competition is a market structure that combines some of the characteristics of a perfectly competitive market and some of the characteristics of a monopoly market structure.
Characteristics of monopolistically competitive markets
Product differentiation
There is a small degree of product differentiation within monopolistic market structures and therefore firms within the market have some element of price making powers. Although this is the case, the price making powers that firms have is still very limited. As a result of this, the average revenue and marginal revenue curve in a monopolistic market structure diagram are more elastic than in the monopoly diagram where firms have greater price making powers.
Low barriers to entry/exit
There are low barriers to entry and exit for firms meaning that in the long run any supernormal profits will be removed through new entrants into the market. In addition to this, firms making sub-normal profits are able to leave the market easily, causing supply to decrease and the price level to increase and therefore allowing for only normal levels of profits to be made. Overall, firms are only able to make normal profits in the long run.
Many buyers and sellers
There are many sellers within the market, thus limiting the price making powers of firms. This is another reason why the average revenue and marginal revenue curves are more elastic than in a monopoly market structure. In addition to this, there are also many buyers within the market.
Non-price competition
Firms will often compete with other firms through non-price methods such as building up their brand through advertising. As such they are able to win over customers from other firms without lowering their prices.
Firms profit maximize
Firms within the market operate at the point where marginal cost is equal to marginal revenue (the profit maximization point).
Profit maximising equilibrium in the short run and long run
Short run
As shown from the diagram above, the average revenue and marginal revenue lines in the monopolistic competition diagram are slightly more elastic than in a monopoly market structure. This represents the small price… Read more