Monopolistic Competition

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Monopolistic Competition

Monopolistic competition is characterised by products that are differentiated and low-to-medium barriers to entry.

Monopolistic competition

There is product differentiation between many small to medium-sized firms.
- E.g Mars bars are not the same as Dairy Milk.
This means that firms in an industry can compete on things other than price (e.g taste of chocolate).
The larger the differences in product, the more inelastic demand is.
There is price and non-price competition.
The barriers to entry are low to medium.
Firms can have some price-setting power and there can be brand loyalty.

Short run

Each firm has some price-making power in monopolistic competition. This means the demand curve slopes downward.
Firms will try to maximise profits by producing where marginal cost is equal to marginal revenue. This is at a higher price than is allocatively efficient.
Firms make supernormal profits in monopolistic competition.
This model is more similar to the model of monopoly.

Long run

The supernormal profits that firms are earning signals to other firms that they should enter the industry.
There are low barriers to entry, so they can join the industry and compete away the supernormal profits in the long run.
So firms only make normal profit in the long run.
This isn't allocatively efficient as the price is too high, or productively efficient as they are producing above the minimum average cost.
But, it is more efficient than under a monopoly situation.

Prices in Monopolistic Competition

Prices under monopolistic competition will tend to be higher than under perfect competition.

Dynamic efficiency

Dynamic efficiency needs firms to make supernormal profits.
Firms in monopolistic competition only make abnormal profits in the short run.
There could be dynamic efficiency if they manage to use non-price competition to maintain supernormal profits.
But this is unlikely because of the lower barriers to entry.

Higher prices

Prices under monopolistic competition tend to be higher than under perfect competition.
- Under monopolistic competition, there is product differentiation.
- This means that firms can spend money on advertising their product for non-price competition. This increases the overall cost of producing and marketing the product.
Firms in perfect competition would not need advertising because we assume there is perfect information.
Firms in monopolistic competition have decide to limit output to maximise profits.

Examples of Monopolistic Competition

In monopolistic competition, firms produce unique or differentiated goods and services but still compete for consumers. Firms set their own prices and quantities of output.

Airlines

Airlines operate in a monopolistically competitive market.
They each provide a travel service with a number of firms offering essentially the same service – flying to and from the same countries, often the same cities and sometimes the same airports.
Different companies have different brands - e.g EasyJet's orange uniforms and planes. Airlines compete on service, reputation and sometimes price.
Price comparison websites like Skyscanner allow customers to compare prices easily.

Pubs

Most pubs offer a similar service, with similar menus & drinks, but prices can vary across pubs.
Pubs can differentiate themselves on service, atmosphere (like Brewdog), the quality of food (gastropubs) or location (like bars with good views of London).
Consumers can become loyal to a brand over time and keep going back to the same pubs.
They generally provide similar goods and services, but can differentiate their offering to get some degree of monopoly power.

Hairdressers

Hairdressers offer essentially the same service but with variations in quality and the price charged.
There can be quite low barriers to entry but brand loyalty and reputation are very important to the success of a business.
Some hairdressers can make significant and sustained profits by charging much higher prices for a superior service.