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Learn about markets with many firms selling differentiated products, such as clothing brands or restaurants.
Why do you pay 1? It’s not just the caffeine—you're paying for a specific 'vibe' and brand promise that generic coffee lacks.
Monopolistic Competition is a market structure that blends elements of both monopoly and perfect competition. Like perfect competition, there are many firms and low barriers to entry. However, like a monopoly, products are differentiated rather than identical. This means each firm has a mini-monopoly over its specific brand or version of a product. Because products are not perfect substitutes, the demand curve () for a single firm is downward sloping, giving the firm some control over its price ().
Consider a city with 50 pizza places. 1. Each shop sells 'pizza,' but they differentiate by crust thickness, sauce recipe, or delivery speed. 2. Because 'Tony’s Pizza' is unique, Tony can raise his price by $1 without losing all his customers to 'Sal’s Pizza.' 3. This differs from perfect competition, where raising the price by even one cent would result in zero sales.
Quick Check
What is the primary reason a monopolistically competitive firm faces a downward-sloping demand curve?
Answer
Product differentiation makes products non-identical, meaning consumers have preferences and won't immediately switch for a small price change.
Firms in this market use advertising to shift their demand curve to the right and make it more inelastic (steeper). If successful, consumers become brand loyal and less sensitive to price changes. However, advertising is a double-edged sword. It increases the firm's Average Total Cost (). For advertising to be profitable, the increase in total revenue from higher prices or volume must exceed the cost of the ad campaign. Mathematically, the firm seeks to maximize profit where , but the curve is higher than it would be without marketing.
A sneaker company spends ATCATC_{new} = ATC_{old} + \\frac{2,000,000}{Q}DPATC$ at the profit-maximizing quantity, the campaign is a success.
Quick Check
If advertising makes a consumer more 'loyal' to a brand, what happens to the elasticity of the demand curve?
Answer
The demand curve becomes more inelastic (steeper).
In the long run, economic profits attract new firms. As new brands enter, the demand for existing firms shifts left until . At this point, firms earn zero economic profit. Unlike perfect competition, this equilibrium occurs at a point where (allocative inefficiency) and is higher than the minimum (productive inefficiency). This gap between the actual output and the output that minimizes is called excess capacity. The market trades efficiency for variety.
In a long-run equilibrium for a boutique clothing store: 1. The firm produces where . 2. At this quantity , the price charged is 100MC = . 4. The markup is 40P > MC$, the firm is not producing the socially optimal amount, leading to deadweight loss.
Which of the following is a characteristic of monopolistic competition?
In the long run, a monopolistically competitive firm's price () is equal to which of the following?
Monopolistically competitive markets are allocatively efficient because they provide a wide variety of products.
Review Tomorrow
In 24 hours, try to explain the concept of 'Excess Capacity' and why it doesn't exist in perfect competition.
Practice Activity
Look at three different brands of bottled water in a store. List three ways they differentiate themselves despite the product being chemically identical ().