Monopolistic Competition – definition, diagram and examples

Definition: Monopolistic competition is a market structure which combines elements of monopoly and competitive markets. Essentially a monopolistic competitive market is one with freedom of entry and exit, but firms can differentiate their products. Therefore, they have an inelastic demand curve and so they can set prices. However, because there is freedom of entry, supernormal profits will encourage more firms to enter the market leading to normal profits in the long term.

A monopolistic competitive industry has the following features:

  • Many firms.
  • Freedom of entry and exit.
  • Firms produce differentiated products.
  • Firms have price inelastic demand; they are price makers because the good is highly differentiated
  • Firms make normal profits in the long run but could make supernormal profits in the short term
  • Firms are allocatively and productively inefficient.

Diagram monopolistic competition short run

monopolistic-competition In the short run, the diagram for monopolistic competition is the same as for a monopoly.

The firm maximises profit where MR=MC. This is at output Q1 and price P1, leading to supernormal profit

Monopolistic competition long run

monopolistic-competition-lr Demand curve shifts to the left due to new firms entering the market.

In the long-run, supernormal profit encourages new firms to enter. This reduces demand for existing firms and leads to normal profit. I

Efficiency of firms in monopolistic competition

  • Allocative inefficient. The above diagrams show a price set above marginal cost
  • Productive inefficiency. The above diagram shows a firm not producing on the lowest point of AC curve
  • Dynamic efficiency. This is possible as firms have profit to invest in research and development.
  • X-efficiency. This is possible as the firm does face competitive pressures to cut cost and provide better products.

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Definition of Unemployment

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Unemployment is defined as a situation where someone of working age is not able to get a job but would like to be in full-time employment. Note: If a mother left work to bring up a child or if someone went into higher education, they are not working but would not be classed as unemployed …

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The effects of an appreciation

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An appreciation means an increase in the value of a currency against other foreign currency. An appreciation makes exports more expensive and imports cheaper. An example of an appreciation in the value of the Pound 2009 – 2012 Jan 2009  If £1 = €1.1 June 2012 £1 = €1.27 In this case, we can say …

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The effect of a current account surplus

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Readers Question: how does a current account surplus affect domestic employment? A current account surplus means an economy is exporting a greater value of goods and services than it is importing. A country with a current account surplus will have a deficit on the financial/capital account. i.e. a country with a current account surplus will …

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AD = C + I + G + X – M

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Readers Question: what does AD stand for in economic terms? AD = Aggregate Demand – the total planned expenditure in an economy. Aggregate Demand is composed of various factors C, I, G, X – M C= Consumer spending I = Investment (Gross Fixed Capital Formation) G= Government Spending X= Exports M= Imports AD places a …

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Money explained

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Definition: Money is an object used as a medium of exchange between two parties. It can have intrinsic value like gold or it can be a universally accepted instrument such as notes and coins printed by a Central Bank. Early money These gold coins are an example of money with an intrinsic value. Made out …

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Pros and cons of Financialisation

Financialisation is a term used to describe the increased role of the financial sector in a modern economy. Source: NYT 2013 Financialisation also refers to particular trends in the financial sector of the economy. This includes: Increased use of financial intermediaries Increased use of futures markets. For example future contracts for bonds, shares, currencies and …

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