2.11.6 (HL)—Monopolistic competition

Monopolistic competition combines rivalry with product differentiation.

Many firms can enter, but branding or design gives each a downward-sloping demand curve and limited short-run price discretion.

Example

Two cafés may charge different prices because location and taste differentiate them, yet new cafés can enter if profits persist.

Link product differentiation to short-run power, then use entry to explain why long-run economic profit is pressured.

Product variety is not proof of perfect competition; each firm still faces its own demand and costs.

In both short and long run, choose $MR=MC$ output and read price from AR. Short-run entry barriers can permit abnormal profit, normal profit or loss. Free entry and exit shift each firm's demand until long-run normal profit where $AR=AC$ at the chosen output. Because product differentiation leaves downward-sloping AR, $P>MC$ and spare capacity imply allocative inefficiency; many substitutes make demand more elastic and inefficiency generally smaller than monopoly while variety is greater.