Economics: Monopolistic Competition

Difficulty:  1/3 (many repeated concepts)
Review: 4/5 (average)

Monopolistic competition occurs when there are no barriers to entry, but all firms create different products, e.g. authors and books. Like a monopoly, profit is maximized at  MR and MC's intersection point. In the short term, a firm can make profits or losses, but over time, ATC drifts toward price at the profit maximization point, similar to like in competitive markets so they make normal profit.

Excess capacity is the region where ATC continues to decrease as quantity increases, while efficient scale is the point where ATC is minimized. Markup is the difference between marginal cost and price. This makes monopolistically competitive firms more willing to accept customers since P > MC.

When firms enter this type of competition, there is the product-variety externality which is positive as consumers see a new product, while there is also the business-stealing externality, negative as one firm takes customers from another.

Advertising is an example of monopolistic competition, with differentiation between products. Some say advertising is just psychological, impedes competition by paying more for similar goods, etc, while others say that it fosters competition by telling information, make entry easier, etc.

Advertising is also a signal of quality, the more expensive the ad, the better the product usually. There's also brand names. Firms with famous brand names gives them incentive to keep up their good quality, but also allowing them to charge more