Monopolisitic Competition

Question 1

Assumptions

Answer 1

Many buyers and sellers (due to diseconomies of scale)
Differentiated products
No barriers to entry or exit (supernormal profit competed away)
Perfect information (consumers know where good is on offer at cheapest price)
No externalities

Question 2

Why this model?

Answer 2

A critique of the perfect competition model (the change in assumptions produce very different welfare conclusions)

Question 3

Examples

Answer 3

Industries with low concentration ratios but small scale branding and local advertising.
(Eg. Computer markets, hairdressing, clothes)

Question 4

Downward sloping demand curve

Answer 4

Less than perfectly elastic despite number of competitors <-> due to product differentiation (each firm produces product with, to an extent, unique characteristics) = if one firm raises their prices not all other firms will

Question 5

Long run equilibrium

Answer 5

Firms are profit maximisers (MR=MC)
In short-run if supernormal profits are made new firms will enter the industry
In long-run only normal profits made

Question 6

Productive inefficiency

Answer 6

The firm has excess capacity (between profit maximising output and minimum average cost)

Question 7

Allocative inefficiency

Answer 7

Price above marginal cost in short-run and long-run

Question 8

Increase in demand

Answer 8

Allow new firms to make supernormal profits <-> attract new entrants, newly differentiated profits occur the demand curve of existing firms will fall and become more elastic (number of close substitutes increase) - continues until new equilibrium achieved at higher output levels

Question 9

Criticisms of the model

Answer 9

Tension between product differentiation and freedom of entry and exit
Not clear on how long-run equilibrium will be achieved
As new firms enter- products will be nearer in characteristics to some than others
Some firms go out of business whereas others still make supernormal profits