Monopolistic competition


5 Characteristics

1. Many buyers and sellers

2.Differentiated goods

3. Almost perfect information

4. Low barriers to entry

5. Some price control

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Like perfect competition in the short run, a firm will make supernormal profits because the AC<AR  at Q1, where the firm is profit maximising (MC=MR). However, because the barriers to entry are still low in this market structure new firms can enter the market. As a result, demand for this firm's good has fallen (because of the increase in close substitutes), in addition to the MR and AR curves increasing in their elasticity, because consumers have become more price sensitive about the goods being produced. The demand curve continues to move to the left until it is tangential to the AC curve. At this point, the monoplistically competitive firm is at its profit-maximising level of output (because MC=MR) but is making normal profit (because AR=AC). This means now the firm is not making any economic profit, because AC now equals AR.

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Disadvantages of mono comp

Not allocatively efficient - prices are above MC. This means that a firm's MC>MR. As a result, total utility is not maximised as suppliers are better off than consumers in the market.

Not productively efficient - saturation of the market may lead to firms being unable to full exploit EOS, causes AC to be higher than if less bigger firms existed.

Critics of heavy spending on marketing and advertising argue that much of this spending is wasted and is an inefficient use of scarce resources.

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