Monopolistic Competition

• A large number of firms compete
• Each firm produces a differentiated product
• Firms compete on product quality, price and marketing
• Firms are free to enter and exit the industry

Product Differentiation

• When the firm makes a product that is slightly different from the products of competing firms

Entry and Exit

• There are no barriers to entry
• Firm cannot make an economic profit in the long run

Price and Output

• The firm in monopolistic competition operates like a single-price monopoly
• The firm produces the quantity at which $MR=MC$ and sells that quantity for the highest possible price
• It makes an economic profit when $P>ATC$

• Long run economic profit $=0, P=ATC$
  • Long-run equilibrium

Compared to Perfect Competition

• Excess capacity - if a firm produces less than the quantity at which ATC is a minimum
• Markup - the amount by which its price exceeds its marginal cost
• Firms operate with excess capcity in long-run equilibrium
  • Produce less than the efficient scale - the quantity at which ATC is a minimum
  • Doward sloping demand curve
• Firms operate with positive markup
  • Result of the downward sloping demand curve

• Firms in perfect competition have no exccess capacity and no markup
  • Result of the perfectly elastic demand curve

Product Development and Marketing

• Firms must continously innovate and develop new products
  • New firms enter similar products compete away economic profits

Advertising

• Increase costs
• Signal quality - send a message to uninformed people
  • Create perception of product differentiation even when th actual product differences are small