Economics Exam: Revision Guide

Monopolistic Competition

Monopolistic competition is a form of imperfect competition and can be found in many real world markets ranging from clusters of sandwich bars and coffee stores in a busy town centre to pizza delivery businesses in a city or hairdressers in a local area. Of all the market structures that we study, this one is the most common in real-life.

The assumptions of monopolistic competition are as follows:

1. There are many producers and consumers in a market - the concentration ratio is low.

2. Consumers perceive that there are non-price differences among the competitors’ products i.e. there is product differentiation (both tangible and intangible).

3. Producers have some control over price - they are ‘price makers’ rather than ‘price takers’ – but less so than monopolies, therefore the demand curve is more elastic than a monopoly, but more inelastic than perfect competition.

4. The barriers to entry and exit into and out of the market are low.

5. Monopolistic firms are profit maximisers.

Relatively Elastic Demand

The characteristics of monopolistic competition mean that a monopolistically competitive firm faces a relatively, but not perfectly, elastic demand curve. Each firm in a monopolistically competitive market can sell a wide range of output within a relatively narrow range of prices.

Demand is relatively elastic in monopolistic competition because each firm faces competition from a large number of  very close substitutes offered by rival firms. However, demand is not perfectly elastic (as in perfect competition) because the output of each firm is slightly different from that of other firms and can ‘make the price’ to some extent, unlike the price-takers in perfect competition. Monopolistically competitive goods are close substitutes, but not perfect substitutes. Strong brand loyalty can have the effect of making demand less sensitive to…