Chapter 17: Monopolistic Competition 1. Monopolistic Competition – a market structure in which many firms sell products that are similar but not identical a. Many sellers b. Product differentiation c. Free entry 2. Competition with Differentiated Products a. The Monopolistically Competitive Firm in the Short Run i. Each firm in a monopolistically competitive market is like a monopoly 1. Because its product is different from those offered by other firms, it faces a downward-sloping demand curve 2. The monopolistically competitive firm follows a monopolist’s rule for profit maximization a. It chooses the quantity at which marginal revenue equals marginal cost and then uses its demand curve to find the price consistent with that quantity 3. A monopolistically competitive firm chooses its quantity and price just as a monopoly does; in the short run, these two types of market structure are similar b. The Long-Run Equilibrium i. Profit encourages entry, and entry shifts the demand curves faced by the incumbent firms to the left 1. As the demand for incumbent firms’ products fall, these firms experience declining profit ii. Losses encourage exit, and exit shifts the demand curves of the remaining firms to the right 1. As the demand for the remaining firms’ products rises, these firms experience rising profit (that is, declining losses) iii. This process of entry and exit continues until the firms in the market are making exactly zero economic profit iv. The demand curve is tangent to the average-total-cost curve 1. These two curves must be tangent once entry and exit have driven profit to zero 2. Because profit per unit sold is the difference between price (found on the demand curve) and average total cost, the maximum profit is zero only if these two curves touch each other without crossing v. Two characteristics describe the long-run equilibrium in a monopolistically competitive market: 1. As in a monopoly market, price exceeds marginal cost 2. As in a competitive market, price equals average total cost vi. Difference between monopoly and monopolistic competition: 1.
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