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8.4 Monopolistic Competition

Learning objectives.

• Explain the significance of differentiated products
• Describe how a monopolistic competitor chooses price and quantity
• Discuss entry, exit, and efficiency as they pertain to monopolistic competition
• Analyze how advertising can impact monopolistic competition

We have now explored the two sides of the spectrum. In perfect competition, we assume identical products, and in a monopoly, we assume only one product is available.

Monopolistic competition lies in-between. It involves many firms competing against each other, but selling products that are distinctive in some way. Examples include stores that sell different styles of clothing, restaurants or grocery stores that sell different kinds of food and even products like golf balls or beer that may be at least somewhat similar but differ in public perception because of advertising and brand names. Firms producing such products must also compete with other styles, flavours and brand names. The term “monopolistic competition” captures this mixture of mini-monopoly and tough competition.

Who invented the theory of imperfect competition?

The theory of imperfect competition was developed by two economists independently but simultaneously in 1933. The first was Edward Chamberlin of Harvard University who published  The Economics of Monopolistic Competition . The second was Joan Robinson of Cambridge University who published  The Economics of Imperfect Competition . Robinson subsequently became interested in macroeconomics where she became a prominent Keynesian, and later a post-Keynesian economist.

Differentiated Products

A firm can try to make its products different from those of its competitors in several ways: physical aspects of the product, selling location, intangible aspects of the product, and perceptions of the product. Products that are distinctive in one of these four ways are called  differentiated products .

Physical aspects of a product include all the phrases you hear in advertisements: such as an unbreakable bottle, nonstick surface, freezer-to-microwave, non-shrink, extra spicy, newly redesigned for your comfort. The location of a firm can also create a difference between producers. For example, a gas station located at a busy intersection can probably sell more gas than one located on a small side-road. A supplier to an automobile manufacturer may find that it is advantageous to locate near the car factory.

Intangible aspects can differentiate a product, too. Some intangible aspects may be promises like a guarantee of satisfaction or money back, a reputation for high-quality services like free delivery, or a loan to purchase the product. Finally,  product perception may occur in the minds of the buyers. For example, many people could not tell the difference in taste between common varieties of beer or cigarettes if they were blindfolded, but because of past habits and advertising, they have strong preferences for certain brands. Advertising can play a role in shaping these intangible preferences.

The concept of differentiated products is closely related to the degree of variety that is available. If everyone in the economy wore only blue jeans, ate only white bread, and drank only tap water, then the markets for clothing, food, and drink would be much closer to perfectly competitive. The variety of styles, flavors, locations, and characteristics creates product differentiation and monopolistic competition.

Perceived Demand for a Monopolistic Competitor

A monopolistically competitive firm faces a demand for its goods that is between monopoly and perfect competition. Figure 8.4a offers a reminder that the demand curve as faced by a perfectly competitive firm is perfectly elastic or flat, because the perfectly competitive firm can sell any quantity it wishes at the prevailing market price . In contrast, the demand curve, as faced by a monopolist, is the market demand curve, since a monopolist is the only firm in the market, and hence is downward sloping.

The demand curve as faced by a monopolistic competitor is not flat, but rather downward-sloping, meaning that the monopolistic competitor, like the monopoly, can raise its price without losing all of its customers or lower its price and gain more customers. Since there are substitutes, the demand curve for a monopolistically competitive firm is relatively more elastic than that of a monopoly, where there are no close substitutes. If a monopolist raises its price, some consumers will choose not to purchase its product—but they will then need to buy a completely different product. However, when a monopolistic competitor raises its price, consumers can choose to buy a similar product from another firm. If a monopolistic competitor raises its price, it will not lose as many customers as would a perfectly competitive firm, but it will lose more customers than a monopoly would.

At a glance, the demand curves faced by a monopoly and monopolistic competitor look similar—that is, they both slope down. Still, the underlying economic meaning of these demand curves is different because a monopolist faces the market demand curve and a monopolistic competitor does not.

Cellular Competition

Recall that monopolistic competition refers to an industry that has more than a few firms that each offer a distinguished product. The Canadian cellular industry is one such market. With a history dating back as far as Alexander Graham Bell’s invention of the telephone in 1876, the Canadian cellular industry now has a number of large firms including Rogers, Telus, and Bell. What about Fido, Koodo, and Virgin Mobile? They are owned by Rogers, Telus, and Bell, respectively. While this market has some similarities to an Oligopoly (which we will not explore in this course), it is often classified as a monopolistic competition.

Consider what you would do if your monthly cell phone bill increased by $2. Would you switch to another company? Likely not. This means that the cellular market is certainly not perfectly competitive as cell phone companies have some ability to change prices. Therefore, the demand faced by each of the cellular companies will be more elastic than market demand, but not perfectly elastic. Let’s explore how these monopolistic competitive firms set prices.

How a Monopolistic Competitor Chooses Price and Quantity

To explore monopolistic competition, let’s consider Rogers, one of the Cellular companies in the market. Rogers faces a downward sloping demand curve and has ATC and MC curves similar to the ones we have seen before.

The monopolistically competitive firm decides on its profit-maximizing quantity and price similar to the way that a monopolist does. Since they face a downward sloping demand curve, the same considerations about how elasticity affects revenue are relevant, and the firm will maximize profits where MR = MC when P > MR.

Step 1.  Rogers determines its profit-maximizing level of output. This will occur where MR = MC. Two situations are possible:

• If the firm is producing at a quantity of output where marginal revenue exceeds marginal cost, then the firm should keep expanding production, because each marginal unit is adding to profit by bringing in more revenue than cost. In this way, the firm will produce up to the quantity where MR = MC.
• If the firm is producing at a quantity where marginal costs exceed marginal revenue, then each marginal unit is costing more than the revenue it brings in, and the firm will increase its profits by reducing the quantity of output until MR = MC.

In this example, MR and MC intersect when Rogers has 3.6 million subscribers.

Step 2. Rogers decides what price to charge. When the firm has determined its profit-maximizing quantity of output, it will behave like a monopoly and charge the maximum it can at the quantity. On the graph, this process can be shown as a vertical line reaching up through the profit-maximizing quantity until it hits the firm’s perceived demand curve. For Rogers, this occurs at a price of $70/month.

Monopolistic Competitors and Entry

Consider the profits of Rogers at equilibrium quantity of 3.6 million subscribers:

At a price of $70/month, ATC is only $60 and Rogers’ profit is $36 million. ($10 profit/subscriber) Notice that this market creates a deadweight loss equal to the red area since the equilibrium quantity is less than what would occur in competitive equilibrium (5 million subscriptions).

Remember that in monopolistic competition, there are few barriers to entry. Since Rogers is earning positive economic profits, other firms will be tempted to enter the market.

The entry of other firms into the same general market shifts the demand curve faced by a monopolistically competitive firm. As more firms enter the market, the quantity demanded at a given price for any particular firm will decline, and the firm’s perceived demand curve will shift to the left. As a firm’s perceived demand curve shifts to the left, its marginal revenue curve will also shift to the left. The shift in marginal revenue will change the profit-maximizing quantity that the firm chooses to produce since marginal revenue will then equal marginal cost at a lower quantity.

When will this shifting stop? When profits are 0. As long as P > ATC firms will continue to enter the market, and demand will continue to shift inward. As shown in Figure 8.4d, this occurs when P = ATC and MR = MC. This specific point happens when Demand is tangent to ATC, because only when this is true can P = ATC, given that ATC is downward sloping (recall that the MC curve passes through ATC at the minimum point of ATC, and note that the minimum point of ATC is at a quantity higher than that produced by the monopolistically competitive firm).

What about the social surplus? Although profits are now 0, a deadweight loss persists. This is because, unlike perfect competition, P > MR, which also means that P > MC. Since consumers’ willingness to pay is greater that the marginal cost of the firm, market failure continues. Remember that a key reason for this is the firms’ inability to charge more that one price. Notice also that ATC is not at a minimum. This is the price the market pays for variety since the aggregate market does not ensure the most efficient production when there is slight differentiation in products.

The Benefits of Variety and Product Differentiation

Even though monopolistic competition does not provide efficiency, it does have benefits of its own. Product differentiation is based on variety and innovation. Many people would prefer to live in an economy with many kinds of clothes, foods, and car styles; not in a world of perfect competition where everyone will always wear blue jeans and white shirts, eat only spaghetti with plain red sauce, and drive an identical model of car. Many people would prefer to live in an economy where firms are struggling to figure out ways of attracting customers by methods like friendlier service, free delivery, guarantees of quality, variations on existing products, and a better shopping experience.

Economists have struggled, with only partial success, to address the question of whether a market-oriented economy produces the optimal amount of variety. Critics of market-oriented economies argue that society does not really need dozens of different athletic shoes or breakfast cereals or automobiles. They argue that much of the cost of creating such a high degree of product differentiation, and then of advertising and marketing this differentiation, is socially wasteful—that is, most people would be just as happy with a smaller range of  differentiated products  produced and sold at a lower price. Defenders of a market-oriented economy respond that if people do not want to buy differentiated products or highly advertised brand names, no one is forcing them to do so. Moreover, they argue that consumers benefit substantially when firms seek short-term profits by providing differentiated products. This controversy may never be fully resolved, in part because deciding on the optimal amount of variety is very difficult, and in part because the two sides often place different values on what variety means for consumers.

How does advertising impact monopolistic competition?

The Canadian economy spent about $12.22 billion on advertising in 2016, according to statista.com.

Advertising is all about explaining to people, or making people believe, that the products of one firm are differentiated from the products of another firm. In the framework of monopolistic competition, there are two ways to conceive how advertising works: either advertising causes a firm’s perceived demand curve to become more inelastic (that is, it causes the perceived demand curve to become steeper), or advertising causes demand for the firm’s product to increase (that is, it causes the firm’s perceived demand curve to shift to the right). In either case, a successful advertising campaign may allow a firm to sell either a greater quantity or to charge a higher price, or both, and thus increase its profits.

However, economists and business owners have also long suspected that much of the advertising may only offset other advertising. Economist A. C. Pigou wrote the following back in 1920 in his book,  The Economics of Welfare :

It may happen that expenditures on advertisement made by competing monopolists [that is, what we now call monopolistic competitors] will simply neutralise one another, and leave the industrial position exactly as it would have been if neither had expended anything. For, clearly, if each of two rivals makes equal efforts to attract the favour of the public away from the other, the total result is the same as it would have been if neither had made any effort at all.

Monopolistic competition refers to a market where many firms sell differentiated products. Differentiated products can arise from characteristics of the good or service, location from which the product is sold, intangible aspects of the product, and perceptions of the product.

If the firms in a monopolistically competitive industry are earning economic profits, the industry will attract entry until profits are driven down to zero in the long run. If the firms in a monopolistically competitive industry are suffering economic losses, then the industry will see an exit of firms until economic profits are driven up to zero in the long run.

A monopolistically competitive firm is not efficient because it does not produce at the minimum of its average cost curve or produce where P = MC. Thus, a monopolistically competitive firm will tend to produce a lower quantity at a higher cost and charge a higher price than a perfectly competitive firm.

Monopolistically competitive industries do offer benefits to consumers in the form of greater variety and incentives for improved products and services. There is some controversy over whether a market-oriented economy generates too much variety.

The following table summarizes the three types of market structure we have examined. The fourth, oligopoly, is not in the scope of this course.

Exercises 8.4

The following TWO questions refer to the diagram below, which illustrates the demand, marginal revenue, and relevant cost curves for a monopolistically competitive firm.

1. How many units of output should this firm produce, in order to maximize profits?

a) 10. b) 25. c) 30. d) 60.

2. In the long run, what price will this firm charge for its output?

a) $10. b) A price less than $10 and greater than $6. c) $6. d) A price less than $6 and greater than $4.

The following TWO questions refer to the diagram below.

3. Which of the four diagrams illustrates a long run equilibrium for a monopolistically competitive firm?

a) Figure 1. b) Figure 2. c) Figure 4. d) Figures 2 and 4.

4. Which of the four diagrams illustrates a monopolistically competitive firm able to make positive economic profits in the short run?

a) Figure 1. b) Figure 2. c) Figures 1 and 2. d) None of the above.

5. Which of the following statements about the comparison between monopolistic competition in the long run and monopoly in the long run is FALSE?

a) Marginal revenue is less than price for both monopoly and monopolistic competition. b) Price is greater than marginal cost for both monopoly and monopolistic competition. c) Price is greater than average total cost for both monopoly and monopolistic competition. d) Neither monopoly or monopolistic competition produce at the minimum point of the average total cost curve.

6. Which of the following statements about the comparison between perfect competition and monopolistic competition is TRUE?

I. Both perfectly competitive and monopolistically competitive firms produce where marginal revenue equals marginal cost. II. Both perfectly competitive and monopolistically competitive firms produce where price equals marginal cost. III. Both perfectly competitive and monopolistically industries are characterized by free entry and zero profits in the long run.

a) I only. b) I and III only. c) I and II only. d) I, II and III.

Principles of Microeconomics Copyright © 2017 by University of Victoria is licensed under a Creative Commons Attribution 4.0 International License , except where otherwise noted.

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• Monopolistic Competition

Written by True Tamplin, BSc, CEPF®

Reviewed by subject matter experts.

Updated on June 08, 2023

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Table of contents, what is monopolistic competition.

Monopolistic competition is a market structure where there are many small firms that produce differentiated products. Unlike perfect competition, each firm has some market power due to product differentiation, which allows them to charge slightly higher prices than their competitors .

However, because there are many firms producing similar but not identical products, consumers have a range of choices and can switch to another product if the price of one becomes too high.

As a result, firms in a monopolistically competitive market must engage in non-price competition, such as advertising and product differentiation, to attract customers.

Characteristics of Monopolistic Competition

Monopolistic competition is characterized by several key features:

Large Number of Small Firms . There are many firms operating in the market, none of which dominates the market.

Differentiated Products . Each firm produces a product that is distinct from its competitors' products, either through quality, design, or branding.

Some Market Power . Each firm has some control over the price of its product due to product differentiation, but this control is limited because there are many substitutes available to consumers.

Non-price Competition . Firms in a monopolistically competitive market compete using advertising, product development, and other marketing strategies to attract customers rather than relying on lower prices.

These characteristics create a market structure that combines elements of both monopoly and perfect competition, resulting in a market where firms have some market power, but not enough to eliminate competition altogether.

Examples of Monopolistic Competition

Monopolistic competition can be observed in a variety of industries, but here are some examples:

Restaurants

These are a good example of monopolistically competitive markets because they offer different types of cuisine, ambiance, and price range, which creates a range of options for consumers.

This differentiation allows each restaurant to have some control over its pricing strategy, but not enough to eliminate competition.

Clothing companies differentiate their products through design, quality, and brand image. This differentiation creates a range of options for consumers, giving each clothing company some market power over its pricing strategy.

Consumers often choose clothing based on brand image, style, and quality, rather than just the price.

Electronics

Companies producing electronics such as smartphones, laptops, and televisions are also good examples of monopolistically competitive markets. These companies differentiate their products through technology, features, and design.

For example, Apple's iPhone and Samsung's Galaxy phones have different designs, features, and operating systems, which create a range of options for consumers.

These industries have many firms competing for market share and offering slightly different products, making them good examples of monopolistically competitive markets.

Benefits of Monopolistic Competition

Monopolistic competition offers several benefits to both consumers and firms:

Consumer Choice

In a monopolistically competitive market, consumers have a range of options to choose from, leading to greater consumer satisfaction and utility.

Product Differentiation

Firms in a monopolistically competitive market differentiate their products, which encourages innovation and leads to a greater variety of products for consumers.

The need for product differentiation in a monopolistically competitive market drives firms to innovate and create new products, technologies, and marketing strategies to attract consumers.

This can lead to technological advancements and greater efficiency in the market.

Overall, monopolistic competition encourages competition, innovation, and variety, benefiting both consumers and firms in the market.

Challenges of Monopolistic Competition

While monopolistic competition offers some benefits, it also presents several challenges:

Barriers to Entry

The product differentiation in monopolistically competitive markets can make it difficult for new firms to enter the market and compete with established firms. This can lead to reduced competition and market inefficiencies.

Higher Prices for Consumers

Firms in a monopolistically competitive market have some market power, which allows them to charge slightly higher prices than in a perfectly competitive market.

This can lead to higher prices for consumers and reduced consumer surplus.

Inefficient Allocation of Resources

Monopolistic competition can lead to an inefficient allocation of resources, as firms may spend resources on advertising and product differentiation rather than on improving their production process.

This can result in less efficient use of resources and higher costs for consumers.

Applications of Monopolistic Competition

Monopolistic competition has several practical applications in business and government policies:

Business Strategy and Marketing

Firms in a monopolistically competitive market must focus on product differentiation and non-price competition to attract customers.

This can include investing in research and development, creating unique brand identities, and developing marketing campaigns to promote their products.

Government Regulation and Antitrust Policies

Because monopolistic competition can lead to market inefficiencies and reduced competition, governments may regulate these markets to promote fair competition and protect consumers.

Antitrust laws may be used to prevent monopolistic practices, such as price-fixing, collusion, or abuse of market power.

Understanding the characteristics and implications of monopolistic competition can help businesses make strategic decisions and help governments develop effective policies to promote competition and protect consumers.

Comparison of Monopolistic Competition with Other Market Structures

Monopolistic competition is just one of several market structures, each with its unique features:

• Perfect Competition

In a perfectly competitive market , many small firms sell identical products with no market power. Prices are determined by supply and demand , and there are no barriers to entry or exit.

Unlike the monopolistic competition, there is no product differentiation or non-price competition.

In a monopoly, there is only one firm in the market with complete market power. The firm can set prices and restrict output without facing competition. There are significant barriers to entry, making it difficult for new firms to enter the market.

Monopolistic competition sits between the extreme market structures of perfect competition and monopoly, with some market power due to product differentiation but still facing competition from other firms.

In an oligopoly, there are only a few firms in the market, each with a significant market share.

The firms may have some market power and engage in non-price competition, but there are significant barriers to entry and exit, making it difficult for new firms to enter the market.

Oligopoly is similar to monopolistic competition in that there are barriers to entry and a small number of firms, but with more market power and less product differentiation.

Final Thoughts

Monopolistic competition is a market structure in which many small firms produce differentiated products, leading to some market power and non-price competition.

This market structure offers benefits such as consumer choice, product differentiation, and innovation but also presents challenges such as barriers to entry, higher prices for consumers, and inefficient allocation of resources.

It is important to note that monopolistic competition is just one of several market structures, each with unique features and implications. You can speak to a wealth management professional to learn more about monopolistic competition.

Monopolistic Competition FAQs

What is monopolistic competition, and how does it differ from perfect competition.

Monopolistic competition is a market structure where many small firms produce differentiated products, creating some market power but still facing competition. Unlike perfect competition, firms have some control over the price of their product due to product differentiation.

What are some examples of industries that demonstrate monopolistic competition?

Monopolistic competition can be observed in industries such as restaurants, clothing, and electronics, where firms differentiate their products through features, design, and branding to attract customers.

What are the benefits of monopolistic competition?

Monopolistic competition offers benefits such as consumer choice, product differentiation, and innovation, as firms must constantly develop new products, technologies, and marketing strategies to remain competitive.

What are the challenges of monopolistic competition?

The need for product differentiation can create barriers to entry, making it difficult for new firms to enter the market and compete with established firms. This can lead to market inefficiencies and higher prices for consumers. Furthermore, monopolistic competition can result in an inefficient allocation of resources.

How can businesses and policymakers navigate the challenges of monopolistic competition?

Understanding the characteristics, benefits, and challenges of monopolistic competition is essential for businesses and policymakers seeking to navigate this market structure effectively. This includes investing in research and development, creating unique brand identities, and developing marketing campaigns to promote their products. Governments may also regulate these markets to promote fair competition and protect consumers through antitrust laws.

About the Author

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide , a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University , where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website or view his author profiles on Amazon , Nasdaq and Forbes .

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Module 10: Monopolistic Competition and Oligopoly

Putting it together: monopolistic competition and oligopoly.

Monopolistically competitive industries consist of a significant number of firms, which each produce a differentiated (or heterogeneous) production. In other words, Colgate, AIM, and Tom’s of Maine each produce toothpaste, but they are not identical products. Like firms in any market structure, if a monopolistically competitive firm wishes to maximize profits, it will supply the quantity of output where marginal revenue equals marginal cost. Like perfectly competitive firms, competition prevents monopolistically competitive firms from earning positive economic profits in the long run, unless those firms create innovative new products and/or use advertising to convince customers they have done so.

Big Mac versus Whopper. Big Mac Snip by Ian Burt, CC-BY . Burger King Whopper by Mike Mozart, CC-BY .

Returning to some of the questions posed in the “Why it Matters” feature at the beginning of this module:

• Why do gas stations charge different prices for a gallon of gasoline? Some gasoline companies use different additives to make their products at least appear different.  This allows them to charge higher prices than companies that don’t make as good a case for their product. Location also matters. A gas station just off the highway can charge higher prices than stations further away, because travelers perceive and are willing to pay for the convenience of the former.
• What determines how far apart the prices of Colgate and Crest toothpaste can be? The answer is brand name loyalty.  To the extent that Colgate users believe Colgate is superior to Crest, they will be willing to pay more for Colgate than for Crest. By contrast, if the two products are perceived to be close substitutes, the prices should be similar.
• Why did fast food restaurants start offering salads? Fast food restaurants added salads to their menus to differentiate their product by appealing to health conscious diners.
• Why did McDonalds come up with the Big Mac sandwich? McDonalds invented the Big Mac because its competitors offered similar enough regular burgers that McDonalds lost its monopoly profits. The Big Mac restored those profits, at least until Burger King came up with the Whopper and other fast food restaurants developed their own special burgers.

While oligopoly is defined as an industry consisting of, or dominated by a small number of firms, the key characteristic is interdependence among firms. Oligopolies can be characterized by collusion, where firms act jointly like a monopolist to share industry profits, or by competition, where firms compete aggressively for individual profits, or something in between. The computer operating system, dominated by Microsoft, fits the former profile with persistent high economic profits. The airline industry (e.g. United) fits the latter profile, leading to prices barely above costs and low profits.

Oligopolies are inefficient for the same reasons that monopolies are—in order to reap economic profits, they produce too little output so they create deadweight losses to society. The more like a monopoly a given oligopoly is, the higher their profits and the greater the deadweight loss. This is why strong oligopolies usually generate antitrust action by the government.

• Putting It Together: Monopolistic Competition and Oligopoly. Authored by : Steven Greenlaw and Lumen Learning. License : CC BY: Attribution

Monopolistic Competition

In many industries the products that firms make are differentiated. For one reason or another, consumers view each firm's brand as different from those of other firms. Crest toothpaste, for example, is different from Colgate, Aim, and a dozen other toothpastes. The difference is partly flavor, partly consistency, and partly reputation-the consumer's image (correct or incorrect) of the relative decay-preventing efficacy of Crest. As a result, some consumers (but not all) will pay more for Crest.

Because Procter & Gamble is the sole producer of Crest, it has monopoly power. But its monopoly power is limited because consumers can easily substitute other brands for Crest if its price rises. Although consumers who prefer Crest will pay more for it, most of them will not pay much more. The typical Crest user might pay 25 or even 50 cents a tube more, but probably not a dollar more. For most consumers, toothpaste is toothpaste, and the differences among brands are small. Therefore, the demand curve for Crest toothpaste, though downward sloping, is fairly elastic. (A reasonable estimate of the elasticity of demand for Crest is -7.) Because of its limited monopoly power, Procter & Gamble will charge a price higher, but not much higher, than marginal cost. The situation is similar for Tide detergent or Scott paper towels.

The Makings of Monopolistic Competition

A monopolistically competitive market has two key characteristics: First, firms compete by selling differentiated products, which are highly substitutable for one another but not perfect substitutes. (In other words, the cross-price elas ticities of demand are large but not infinite.) Second, there is free entry and exit-it is relatively easy for new firms to enter the market with their own brands of the product and for existing firms to leave if their products become unprofitable.

To see why free entry is an important requirement, lets compare the markets for toothpaste and automobiles. The toothpaste market is monopolistic ally competitive, but the automobile market is better characterized as an oligopoly. It is relatively easy for other firms to introduce new brands of toothpaste that might compete with Crest, Colgate, and so on. This limits the profitability of producing Crest or Colgate. If the profits were large, other firms would spend the necessary money (for development, production, advertising, and promotion) to introduce new brands of their own, which would reduce the market shares and profitability of Crest and Colgate.

The automobile market is also characterized by product differentiation. However, the large-scale economies involved in production make entry by new firms difficult. Hence, until the mid-1970s when Japanese producers became important competitors, the three major U.S. automakers had the market largely to themselves.

There are many other examples of monopolistic competition besides toothpaste. Soap, shampoo, deodorants, shaving cream, cold remedies, and many other items found in a drugstore are sold in monopolistic ally competitive markets. The markets for bicycles and other sporting goods are likewise monopolistic ally competitive. So is most retail trade, since goods are sold in many different retail stores that compete with one another by differentiating their services according to location, availability and expertise of salespeople, credit terms,etc. Entry is relatively easy, so if profits are high in a neighborhood because there are only a few stores, new stores will enter.

Equilibrium in the Short Run and the Long Run

As with monopoly, in monopolistic competition firms face downward-sloping demand curves and therefore have monopoly power. But this does not mean that monopolisLically competitive firms are likely to earn large profits. Monopolistic competition is also similar to perfect competition. There is free entry, so the potential to earn profits will attract new firms with competing brands, driving profits down to zero.

To make this clear, let's examine the equilibrium price and output level for a monopolistically competitive firm in the short and long run. Figure 12. la shows the short-run equilibrium. Because the firrr's product differs from its competitors', its demand curve Dsr is downward sloping. (This is the firm's demand curve, not the market demand curve, which is more steeply sloped.) The profit-maximizing quantity Qsr is found at the intersection of the marginal revenue and marginal cost curves. Since the corresponding price Psr exceeds average cost, the firm earns a profit, as shown by the shaded rectangle in the figure.

In the long run, this profit will induce entry by other firms. As they introduce competing brands, this firm will lose market share and sales; its demand

FIGURE 12.1 A Monopolistically Competitive Firm in the Short and Long Run. Be cause the firm is the only producer of its brand, it faces a downward-sloping demand curve; price exceeds marginal cost, and the firm has monopoly power. In the short run, (a), price also exceeds average cost, and the firm earns profits shown by the tan-shaded rectangle. In the long run, these profits attract new firms with competing brands into the industry. The firm's market share falls, and its demand curve shifts downward. In long-run equilibrium, (b), price equals average cost, so the firm earns zero profit, even though it has monopoly power.

curve will shift down, as in Figure 12.1b. (In the long run, the average and marginal cost curves may also shift. We have assumed for simplicity that costs do not change.) The long-run demand curve Di.r will be Just tangent to the firm's average cost curve. Here profit maximization implies the quantity Qlr the price P\.r, and zero profit because price is equal to average cost. The firm still has monopoly power; its long-run demand curve is downward sloping because the firm's particular brand is still unique. But the entry and competition of other firms have driven its profit to zero.

More generally, firms may have different costs, and some brands will be more distinctive than others. In this case firms may charge slightly different prices, and some will earn a small profit.

Continue reading here: Monopolistic Competition and Economic Efficiency

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Readers' Questions

Which of the following is true for a monopolistically competitive firm in longrun equilibrium?

There are a few possible options that could be true for a monopolistically competitive firm in long-run equilibrium. Here are a few possibilities: The firm is making zero economic profit: In the long run, firms in monopolistic competition tend to have zero economic profit. This means that their total revenue is equal to their total costs, including both explicit (e.g., rent, wages) and implicit costs (e.g., opportunity costs). Any positive economic profit would attract new firms to enter the market, reducing demand for existing firms' products and bringing the profit down to zero. The firm is differentiated: In monopolistic competition, firms differentiate their products in some way to create a perceived difference in quality, style, branding, etc. This product differentiation allows firms to have some market power, meaning they can charge a price higher than their marginal cost. In long-run equilibrium, firms continue to differentiate their products, but without excessive price competition since they still face competitive pressures from other firms in the market. The firm faces downward-sloping demand: In long-run equilibrium, a monopolistically competitive firm's demand curve is still downward-sloping, although it may be more elastic than a monopolist's demand curve. This means that a price increase by the firm would result in a decrease in the quantity demanded, and vice versa. However, the firm does not face a perfectly elastic demand curve like a perfectly competitive firm. It is important to note that these conditions are general characteristics of monopolistic competition, and the exact details can vary depending on the specific market and firm.

Is procter and gamble a monopoly?

No, Procter & Gamble (P&G) is not a monopoly. A monopoly refers to a situation in which there is only one seller of a particular product or service, or a dominant company that effectively controls a specific market. P&G is a multinational consumer goods company that operates in various industries such as healthcare, cleaning products, hygiene, and personal care. While P&G holds a significant market share in some of these industries, it faces competition from other companies, both large and small, thereby preventing it from being a monopoly.

When new firms enter a monopolistically competitive market, the economic profits of existing firms?

When new firms enter a monopolistically competitive market, the economic profits of existing firms will decrease due to increased competition. New firms will put downward pressure on prices, meaning existing firms will have to lower their prices in order to remain competitive. This will reduce the profits of existing firms.

Which of the following industries is an example of monopolistic competition?

Why do most firms in monopolistic competition typically make zero profit in the long run?

Most firms in monopolistic competition typically make zero profit in the long run because they are competing against each other for market share and customers find it difficult to differentiate between them. This leads to price competition which reduces the profits of the firms. This situation is further exacerbated by the entry and exit of firms, as new firms enter the market to take advantage of any potential profit opportunities and existing firms exit the market due to the inability to make a profit.

Which of the following goods are not likely to be sold in monopolistically competitive markets?

What is true of a monopolistically competitive market in longrun equilibrium?

In a monopolistically competitive market in longrun equilibrium, firms are producing at the output level where marginal cost equals marginal revenue, and economic profits are zero. There is product differentiation among the firms, and price is slightly higher than marginal cost. Consumers have some choice between the products of different firms, but there is no single price-setting firm.

Why do monopolistically competitive firms have downwardsloping demand curves?

Monopolistically competitive firms have downward-sloping demand curves because of the presence of product differentiation. This means that each firm's product is unique in some way, and consumers are willing to pay a premium for that product. As a result, demand for the firm's product is less elastic than for a perfectly competitive firm's product, since buyers recognize that there is no substitute for the unique product. Since demand is less elastic, it is more sensitive to changes in price, leading to a downward-sloping demand curve.

Which of the following markets is an example of monopolistic competition?

A retail clothing store.

How is monopolistic competition similar to monopoly?

Monopolistic competition is similar to monopoly in that both involve a single firm controlling the market and setting prices. However, in monopolistic competition, other firms may enter the market, creating a form of competition that sets prices at levels lower than what would be observed under a monopoly. Both forms of market structure can lead to higher prices, lower output, and decreased customer welfare.

When a market is monopolistically competitive, the typical firm in the market can earn?

In a monopolistically competitive market, firms can typically earn normal profits. Normal profits occur when the firm earns just enough revenue to cover all of its costs over the long run. In other words, firms in a monopolistically competitive market can earn their opportunity cost of capital.

Which of the following goods are likely to be sold in a monopolistically competitive market?

-Clothing -Souvenirs -Fast food -Sports equipment -Books -Cosmetics -Jewelry

Which of the following industries is best characterized as monopolistically competitive?

Retail clothing stores

Which industry would be best characterized as monopolistically competitive?

Retail Service Industries, such as restaurants, clothing stores, and hair salons.

Why marginal revenue is different fron price in monopolistic competition?

Marginal revenue is different from price in monopolistic competition because price is fixed by the individual firm and does not change, whereas marginal revenue does change depending on the quantity of output produced by the firm. In other words, marginal revenue is the additional revenue earned from selling an extra unit of a good or service. The price of the good or service is not affected but the total revenue earned by selling that unit is impacted. Therefore, marginal revenue differs from price in monopolistic competition since it is affected by the quantity of output sold by the firm.

Is crest toothpaste monopolistically competitive?

No, Colgate Crest toothpaste is not monopolistically competitive. It is a monopolistically protected brand, meaning that it has a patent protecting it from competitors.

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Monopolistic Competition

In many industries, the products are differentiated. For one reason or another, con- sumers view each firm’s brand as different from other brands. Crest toothpaste, for example, is perceived to be different from Colgate, Aim, and other toothpastes. The difference is partly flavor, partly consistency, and partly reputation—the con- sumer ’s image (correct or incorrect) of the relative decay-preventing efficacy of Crest. As a result, some consumers (but not all) will pay more for Crest.

Because Procter & Gamble is the sole producer of Crest, it has monopoly power. But its monopoly power is limited because consumers can easily sub- stitute other brands if the price of Crest rises. Although consumers who prefer Crest will pay more for it, most of them will not pay much more. The typical Crest user might pay 25 or 50 cents a tube more, but probably not one or two dollars more. For most consumers, toothpaste is toothpaste, and the differences among brands are small. Therefore, the demand curve for Crest toothpaste, though downward sloping, is fairly elastic. (A reasonable estimate of the elastic- ity of demand for Crest is −5.) Because of its limited monopoly power, Procter & Gamble will charge a price that is higher, but not much higher, than marginal cost. The situation is similar for Tide detergent or Scott paper towels.

1. T h e Makings of Monopolistic Competition

A monopolistically competitive market has two key characteristics:

• Firms compete by selling differentiated products that are highly substitut- able for one another but not perfect substitutes. In other words, the cross- price elasticities of demand are large but not infinite.
• There is free entry and exit: It is relatively easy for new firms to enter the market with their own brands and for existing firms to leave if their prod- ucts become unprofitable.

To see why free entry is an important requirement, let’s compare the mar- kets for toothpaste and automobiles. The toothpaste market is monopolistically competitive, but the automobile market is better characterized as an oligopoly. It is relatively easy for other firms to introduce new brands of toothpaste, and this limits the profitability of producing Crest or Colgate. If the profits were large, other firms would spend the necessary money (for development, produc- tion, advertising, and promotion) to introduce new brands of their own, which would reduce the market shares and profitability of Crest and Colgate.

The automobile market is also characterized by product differentiation. However, the large-scale economies involved in production make entry by new firms difficult. Thus, until the mid-1970s, when Japanese producers became important competitors, the three major U.S. automakers had the market largely to themselves.

There are many other examples of monopolistic competition besides toothpaste. Soap, shampoo, deodorants, shaving cream, cold remedies, and many other items found in a drugstore are sold in monopolistically competitive markets. The mar- kets for many sporting goods are likewise monopolistically competitive. So is most retail trade, because goods are sold in many different stores that compete with one another by differentiating their services according to location, availability and expertise of salespeople, credit terms, etc. Entry is relatively easy, so if profits are high in a neighborhood because there are only a few stores, new stores will enter.

2. E q u i l ib rium in the Short Run and the Long Run

As with monopoly, in monopolistic competition firms face downward-sloping demand curves. Therefore, they have some monopoly power. But this does not mean that monopolistically competitive firms are likely to earn large profits. Monopolistic competition is also similar to perfect competition: Because there is free entry, the potential to earn profits will attract new firms with competing brands, driving economic profits down to zero.

To make this clear, let’s examine the equilibrium price and output level for a monopolistically competitive firm in the short and long run. Figure 12.1(a) shows the short-run equilibrium. Because the firm’s product differs from its competi- tors’, its demand curve D S R   is downward sloping. (This is the firm’s demand curve, not the market demand curve, which is more steeply sloped.) The profit- maximizing quantity Q S R   is found at the intersection of the marginal revenue and marginal cost curves. Because the corresponding price P SR   exceeds average cost, the firm earns a profit, as shown by the shaded rectangle in the figure.

In the long run, this profit will induce entry by other firms. As they intro- duce competing brands, our firm will lose market share and sales; its demand curve will shift down, as in Figure 12.1(b). (In the long run, the average and marginal cost curves may also shift. We have assumed for simplicity that costs do not change.) The long-run demand curve D LR will be just tangent to the firm’s average cost curve. Here, profit maximization implies the quantity Q LR   and the price P LR . It also implies ze ro profit because price is equal to average cost. Our firm still has monopoly power: Its long-run demand curve is downward slop- ing because its particular brand is still unique. But the entry and competition of other firms have driven its profit to zero.

More generally, firms may have different costs, and some brands will be more distinctive than others. In this case, firms may charge slightly different prices, and some will earn small profits.

3. M o n o p o li s t i c Competition and Economic Efficiency

Perfectly competitive markets are desirable because they are economically effi- cient: As long as there are no externalities and nothing impedes the workings of the market, the total surplus of consumers and producers is as large as possible. Monopolistic competition is similar to competition in some respects, but is it an efficient market structure? To answer this question, let’s compare the long-run equilibrium of a monopolistically competitive industry to the long-run equilib-rium of a perfectly competitive industry.

Figure 12.2 shows that there are two sources of inefficiency in a monopolisti-cally competitive industry:

• Unlike perfect competition, with monopolistic competition the equilibri- um price exceeds marginal cost. This means that the value to consumers of additional units of output exceeds the cost of producing those units. If output were expanded to the point where the demand curve intersects the marginal cost curve, total surplus could be increased by an amount equal to the yellow-shaded area in Figure 12.2(b). This should not be surprising. We saw in Chapter 10 that monopoly power creates a deadweight loss, and monopoly power exists in monopolistically competitive markets.
• Note in Figure 12.2(b) that for the monopolistically competitive firm, out- put is below that which minimizes average cost. Entry of new firms drives profits to zero in both perfectly competitive and monopolistically competi- tive markets. In a perfectly competitive market, each firm faces a horizon- tal demand curve, so the zero-profit point occurs at minimum average cost, as Figure 12.2(a) shows. In a monopolistically competitive market, how- ever, the demand curve is downward sloping, so the zero-profit point is to the left of minimum average cost. Excess capacity is inefficient because average cost would be lower with fewer firms.

These inefficiencies make consumers worse off. Is monopolistic competi- tion then a socially undesirable market structure that should be regulated? The answer—for two reasons—is probably no:

•   In most monopolistically competitive markets, monopoly power is smaill. Usually enough firms compete, with brands that are sufficiently substitutable, so that no single firm has much monopoly power. Any resulting deadweight loss will therefore be small. And because firms’ demand curves will be fairly elastic, average cost will be close to the minimum.

2. Any inefficiency must be balanced against an important benefit from monopolistic competition: product diversity. Most consumers value the ability to choose among a wide variety of competing products and brands that differ in various ways. The gains from product diversity can be large and may easily outweigh the inefficiency costs resulting from downward- sloping demand curves

Source: Pindyck Robert, Rubinfeld Daniel (2012), Microeconomics , Pearson, 8th edition.

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Home Essay Samples Business Mcdonald's

Analysis of Monopolistic Competition on the Example of McDonald's

Table of contents

Introduction, examples of monopolistic competition: mcdonald’s.

• perfect competition
• monopolistic competition
• McDonald's Corporation. (2021). 2020 Annual Report. Retrieved from https://www.aboutmcdonalds.com/content/dam/AboutMcDonalds/Investors/2020%20Annual%20Report.pdf
• Beasley, M. (2016). The McDonaldization of Society: An Investigation into the Changing Character of Contemporary Social Life (8th ed.). Sage Publications.
• Bishop, M. (2019). Monopolistic Competition. Investopedia. Retrieved from https://www.investopedia.com/terms/m/monopolisticcompetition.asp
• Gabaix, X., & Laibson, D. (2019). Shrouded Attributes, Consumer Myopia, and Information Suppression in Competitive Markets. The Quarterly Journal of Economics, 134(1), 511-551. https://doi.org/10.1093/qje/qjy025
• Gregoriou, A. (2020). Monopolistic Competition and the Welfare Effects of Trade Liberalization. Journal of International Trade & Economic Development, 29(3), 269-299. https://doi.org/10.1080/09638199.2019.1665826
• Lutz, A. (2017). Why McDonald's Is One of the Most Monopolistic Companies in America. Business Insider. Retrieved from https://www.businessinsider.com/mcdonalds-is-one-of-the-most-monopolistic-companies-in-america-2017-10
• Mises, L. von. (1990). Human Action: A Treatise on Economics (4th ed.). Fox & Wilkes.
• Perloff, J. (2014). Microeconomics (7th ed.). Pearson Education, Inc.
• Rosenbaum, D. (2019). McDonald's: A Monopoly in the Fast Food Industry? Investopedia. Retrieved from https://www.investopedia.com/articles/investing/030916/mcdonalds-monopoly-fast-food-industry.asp
• Trefis Team. (2020). What Is McDonald's Business Model? Forbes. Retrieved from https://www.forbes.com/sites/greatspeculations/2020/07/29/what-is-mcdonalds-business-model/?sh=52f3dfdb149a

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