AP Economics

Mr. Bernstein

Module 67: Introduction to Monopolistic Competition

December 2015

2

AP EconomicsMr. Bernstein

Characteristics of Monopolistic Competition• Like Perfect Competition:

• Many firms (too many to allow tacit collusion but fewer than Perfect Competition)

• No barriers to entry or exit

• Like Monopoly:• Some ability to set pricing – faces downward sloping D

• But Unlike Perfect Competition or Monopoly…• Products differentiated vs competition

• Examples• Local restaurants, retail groceries or clothing stores

3

AP EconomicsMr. Bernstein

Monopolistic Competition in the Short Run• D is downward sloping• In Short Run, set P andQ as a Monopoly would• Can earn profit in short run

4

AP EconomicsMr. Bernstein

Monopolistic Competition in the Short Run• Can also earn loss in short run

5

AP EconomicsMr. Bernstein

Monopolistic Competition in the Long Run• Entry and exit can occurin response to short-runprofits or losses• Same adjustmentprocess as Perfect Comp.• Firms will earn normal profit in the long run• P*=ATC, tangent to ATC (not at minimum…)

6

AP EconomicsMr. Bernstein

Monopolistic Competition vs. Perfect Competition• Normal profits in both (easy entry and exit)• MR=MC in both• In Perfect Comp, ATC=P=MR=MC, but in

Monopolistic Comp ATC=P > MR=MC…on the downward sloping range of ATC

• So Monopolistic Comp in not productively efficient (P=ATC min) and output is less than in Perfect Comp. Economists call this excess capacity

7

AP EconomicsMr. Bernstein

Is Monopolistic Competition Inefficient?• Since P>MC, DWL does occur• Because there is some competition, the wedge

between P and MC is smaller than in monopoly• Differentiated products bring variety to consumers• Differentiated products also bring some pricing

power to producers (the price of variety?)