Four Market Model Summary: Monopolistic Competition - Online Tutor, Practice Problems & Exam Prep

Monopolistic competition features many firms, similar to perfect competition, but with product differentiation, as seen in fast food markets like Burger King and McDonald's. Barriers to entry are low, allowing easy market entry. Firms maximize profit where marginal revenue equals marginal cost. In the long run, economic profit is zero, as price equals average total cost. The demand curve is downward sloping, leading to price being greater than both marginal revenue and marginal cost, indicating a markup. Understanding these dynamics is crucial for analyzing market structures and their implications on economic outcomes.

Four Market Model Summary: Monopolistic Competition

Alright guys, we've done it. We've reached the end of monopolistic competition, so let's go ahead and fill in that market model summary sheet. Remember, at the beginning of the perfect competition section, there was a sheet that had 4 columns in it, one for each market structure. I want you to pull that sheet up and we're going to fill in the monopolistic competition column there, alright? So let's go ahead and go down one by one here.

So the first one here, number of firms, we saw that there are many firms in monopolistic competition, right? There was a lot of competition, but it's not as much as perfect competition. When we think of perfect competition theoretically, it's almost an infinite amount of firms compared to here, where there are still quite a lot. There are still many, many firms. There's a lot of competition here, okay? Some good examples that we talked about in this chapter include fast food markets. When we were talking about Burger King, McDonald's, and other fast food joints, right? So that was a great example of a monopolistically competitive market. Coffee as well, right? We talked about Starbucks coffee and their competition as well.

Barriers to entry are what keep you from starting up in this market, right? So if you wanted to start a fast food joint, all you'd have to do is go rent a space, get started, and you could set up a fast food joint. So there's not really any barriers to entry to get into a monopolistically competitive market, right? It's just like in perfect competition. We saw that there was no barrier to entry there as well, right? If you wanted to start a farm for wheat, you just go buy a farm and you'd start farming. Cool?

So we saw profit-maximizing quantity here as well was where marginal revenue equals marginal cost, right? That's where we're going to find our profit-maximizing quantity, and that is the quantity we will produce and then find our profit using price from the demand curve and average total cost from the average total cost curve. Right? And we saw in the long run, profitability, there was no economic profit, right? That price was going to equal average total cost in the long run. So there's no possibility for economic profit in the long run because the price equals average total cost.

Alright, how about the relationship between price and marginal revenue? Well, we saw we had that downward-sloping demand curve to the firm, right, and since they have a downward-sloping demand curve, that marginal revenue is going to be less than the price, right? The price comes from the demand curve, but that marginal revenue is less than that, so price is greater than marginal revenue here. Right? And last, the relationship between price and marginal cost. Well, we also saw that the marginal cost is also going to be less than the price, so price is greater than marginal cost as well, okay? So that's that markup over marginal cost that we see, where we cross marginal revenue and marginal cost to find our point where we're going to produce and then we're going to go up to find our price on the demand curve. Okay?

So remember this isn't everything we talked about. We talked about some other topics as well, right. We showed how to calculate profit on the graph and things like that, so this doesn't include everything that we've discussed. There's also other details, but this is some good high-level stuff that you can compare between the different market structures. Alright. Cool. So let's go ahead and move on to the next chapter.

Here’s what students ask on this topic:

What are the characteristics of monopolistic competition?

Monopolistic competition is characterized by many firms in the market, similar to perfect competition, but with product differentiation. This means that each firm offers a product that is slightly different from its competitors, such as fast food chains like Burger King and McDonald's. Barriers to entry are low, allowing new firms to enter the market easily. Firms maximize profit where marginal revenue (MR) equals marginal cost (MC). In the long run, economic profit is zero because price (P) equals average total cost (ATC). The demand curve is downward sloping, leading to P being greater than both MR and MC, indicating a markup over marginal cost.

How do firms in monopolistic competition determine their profit-maximizing output?

Firms in monopolistic competition determine their profit-maximizing output by producing where marginal revenue (MR) equals marginal cost (MC). This is the point where the additional revenue from selling one more unit equals the additional cost of producing that unit. Mathematically, this is represented as:

$\mathrm{MR}=\mathrm{MC}$

Once the profit-maximizing quantity is determined, the firm uses the demand curve to find the corresponding price. The difference between the price and the average total cost (ATC) at this quantity determines the firm's profit or loss.

Why is there no economic profit in the long run in monopolistic competition?

In the long run, there is no economic profit in monopolistic competition because new firms can enter the market due to low barriers to entry. As new firms enter, the market supply increases, driving down the price. Eventually, the price falls to the point where it equals the average total cost (ATC), eliminating economic profit. This is represented as:

$P=\mathrm{ATC}$

At this point, firms earn just enough to cover their costs, including a normal profit, but no economic profit. This process ensures that in the long run, firms in monopolistic competition only break even.

How does product differentiation impact monopolistic competition?

Product differentiation is a key feature of monopolistic competition, where firms offer products that are slightly different from their competitors. This differentiation can be based on quality, features, branding, or customer service. It allows firms to have some degree of market power, enabling them to set prices above marginal cost. However, because products are not perfect substitutes, the demand curve for each firm's product is downward sloping. This means that firms face a trade-off between price and quantity sold. Product differentiation also leads to non-price competition, where firms compete through advertising, product improvements, and other means to attract customers.

What is the relationship between price and marginal cost in monopolistic competition?

In monopolistic competition, the price (P) is greater than the marginal cost (MC) due to the downward-sloping demand curve. This relationship indicates a markup over marginal cost, which is a result of product differentiation and the firm's market power. Mathematically, this can be expressed as:

$P>\mathrm{MC}$

The markup allows firms to cover their average total costs (ATC) and earn a normal profit in the long run. However, the presence of many firms and low barriers to entry ensure that economic profit is zero in the long run, as new firms enter the market and drive down prices.