Monopolistic competition is a market structure in which there are many firms sell products that are similar but not identical. For example the market of books. There are many writing and publishers selling the similar products (books) and competing for the same costumers. Sellers can enter the market freely so that the market is less profitable. On the other hand, each book has different genre and name. So, each publisher has different consideration of how much to charge.
In monopolistic competition, we can see the following combination of characteristics between monopoly and perfectly competitive market:
1. Many sellers: There are many firms competing for the same group of costumers.
2. Product differentiation:
Each producer offers products that are not identical. Thus, rather than being a price taker, each producer follows the downward sloping curve.
3. Free entry :
Firms can enter or exit without any restriction. Thus, the number of firms adjusts until the remaining firms obtain zero economic profit
The Monopolistically Competitive Firm in the Short Run
In the short run, firms in monopolistically competitive market is like a monopoly. Because each firm offers different product so it follows downward sloping demand curve. When they offer products in higher price, the consumers’ willingness to pay will be lower. The monopolistically competitive firms follow the rule for profit maximization. They get maximum profit when marginal revenue equal to marginal cost and then uses the demand curve to determine the price.
They make profit: when the market price which is shown by the demand curve exceeds the ATC
They suffer loss: when the market price is below the ATC
The Long Run Equilibrium
In the long run when firms make profit, it will give incentive to the outside firms to enter the market. As a result, it will rise the amount of goods in the market that gives wider preferences for costumers, then decrease the demand faced by the incumbent firms, and...