AP Economics Mr. Bernstein Module 67: Introduction to Monopolistic Competition December 2015

AP Economics Mr. Bernstein Characteristics of Monopolistic Competition Like Perfect Competition: Many firms (too many to allow tacit collusion but fewer than Perfect Competition) No barriers to entry or exit Like Monopoly: Some ability to set pricing – faces downward sloping D But Unlike Perfect Competition or Monopoly… Products differentiated vs competition Examples Local restaurants, retail groceries or clothing stores 2

AP Economics Mr. Bernstein Monopolistic Competition in the Short Run D is downward sloping In Short Run, set P and Q as a Monopoly would Can earn profit in short run 3

AP Economics Mr. Bernstein Monopolistic Competition in the Short Run Can also earn loss in short run 4

AP Economics Mr. Bernstein Monopolistic Competition in the Long Run Entry and exit can occur in response to short-run profits or losses Same adjustment process as Perfect Comp. Firms will earn normal profit in the long run P*=ATC, tangent to ATC (not at minimum…) 5

AP Economics Mr. Bernstein Monopolistic Competition vs. Perfect Competition Normal profits in both (easy entry and exit) MR=MC in both In Perfect Comp, ATC=P=MR=MC, but in Monopolistic Comp ATC=P > MR=MC…on the downward sloping range of ATC So Monopolistic Comp in not productively efficient (P=ATC min) and output is less than in Perfect Comp. Economists call this excess capacity 6

AP Economics Mr. Bernstein Is Monopolistic Competition Inefficient? Since P>MC, DWL does occur Because there is some competition, the wedge between P and MC is smaller than in monopoly Differentiated products bring variety to consumers Differentiated products also bring some pricing power to producers (the price of variety?) 7