Monopolistic Competition

Characteristics of a Monopolistic Competition (AO2)

A monopolistic competition is a market structure with the following characteristics:

• Quite a few firms

• Slightly differentiated products: The goods and services the firms offer are slightly different from each other

• Some barriers to entry, but not very large

• Little market power: Since there are quite a few firms, each has a little control over the market

• Firms are price makers: Given their market power, they have the ability to choose their own prices and not the market equilibrium price

Monopolistic Competition Diagrams (AO4)

The diagram is very similar to the monopoly diagram, with two small changes:

• The D = AR line is slightly more elastic (less steep). This is because since the products are only slightly differentiated, so can easily be substituted (if one price suddenly increases, consumers can easily switch to another firm)

• The default state is always normal profit. This is because, similarly to in perfect competition, firms can enter or exit if abnormal profits or losses are made

There are three forms of the monopolistic competition diagram you need to know how to draw:

1. When the firm is making normal profit (Costs = Revenue)

2. When the firm is making a loss (Costs > Revenue)

3. When the firm is making abnormal profit (Costs < Revenue)