Page 184 - DECO405_MANAGERIAL_ECONOMICS

Unit 11: Monopolistic Competition

Notes
Figure 11.2: Long-run Firm’s Equilibrium under Monopolistic Competition

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Caution When there is competition only from new entry, the long run equilibrium of the
firm under monopolistic competition is reached under the following conditions:
1. Price = AR = LAC = OP (Figure 11.2)
2
2. MR = LMC = EQ (Figure 11.2)
2
3. Maximum Profit = Normal Profits
However, because the firm's demand or average revenue curve is falling, the price is higher
than marginal revenue. Hence, under monopolistic competition, even though the long run
equilibrium price is = LAC, it is greater than LMC. This is because, at equilibrium, MR = LMC
but price is greater than MR. (Under perfect competition, price = minimum LAC = LMC).
Moreover, since the firm's demand or average revenue AR is falling on account of product
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differentiation, it can be a tangent to the U-shaped LAC curve only when LAC is also falling. As
shown in Figure 11.2, the long run equilibrium position E will be at a point which is to the left

of the minimum LAC. Thus, the long run equilibrium output Q is less than optimum output, Q
m
(where LAC is at its minimum). The difference between E and Q = (F – OQ) shows the extent of

excess or under utilised capacity. Equilibrium with excess capacity is therefore the necessary
consequence of product differentiation and monopolistic competition.

Task Analyse the “market entry and the vanilla syndrome” in the case of health
and retirement plans of insurance companies.

11.3 Application of Monopolistic Competition

We find many examples of monopolistic competition in real world. The best examples can be
found in retail trade. As we know the main characteristics for this type of market situation is that
there are many producers and many customers for the services/products, yet no company has
control over the market price, consumers perceive that there are non-price differences among
the competitors' products, and there are very few barriers to entry to and exit from the market.
Those markets which have these characteristics, the differentiation of products is often achieved
by altering the physical composition of products, or through advertising to claim the superiority
of the product. This can easily be seen in markets for toothpastes or soaps etc. Under monopolistic

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