A LevelEconomicsAQARevision NotesIndividuals, Firms, Markets & Market Failure5. Perfect & Imperfectly Competitive Markets & MonopoliesMonopolistic Competition

Monopolistic Competition (AQA A Level Economics)

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Lorraine

Written by: Lorraine

Reviewed by: Steve Vorster

Characteristics of Monopolistically Competitive Markets

  • A monopolistic market structure is one in which there are many firms offering a similar product but with some product differentiation

  • Examples include

    • Nail salons, hairdressing or barber shops, massage parlours, fruit and vegetable stores

Diagram: Monopolistic Competition

ibdp-economics---levels-of-competition-and-concentration-in-different-structures

Monopolistic competition should not be confused with a monopoly. As a market structure, it sits closer to perfect competition
 

Characteristics of Monopolistic Competition

Characteristic

Explanation

Characteristic

Explanation

Nature of the product

  • The products are slightly differentiated
     

  • This structure exists as consumers have different desires

    • E.g. Two nail bars differentiate their product through express or pampered service - a relatively homogenous product has now been differentiated

Degree of efficiency

  • More competition pushes the firm to better efficiency
     

  • Allocative efficiency in the long-run

Customer loyalty

  • Relatively low due to number of substitutes

  • However, can also be relatively strong based on client/customer relationship, e.g loyalty to a specific hairdresser

Type of profit

  • Can be abnormal in the short-run
     

  • Normal (breakeven) in the long-run

Price taker or maker?

  • Some price setting ability

Level of market power

  • There is a low degree of market power

Barriers to entry

  • There are low barriers to entry and exit from the industry
     

  • Firms can start-up or leave the industry with relative ease, which increases the level of competition

Slope of the demand curve

  • Shallow (elastic)
     

  • Same shape as monopoly revenue curves, but those are steeper (more inelastic)

Number of firms

  • There are a large number of small firms

  • Each one is relatively small and can act independently of the market

 

 

Short-run Abnormal Profits in Monopolistic Competition

  • In order to maximise profit, firms in monopolistic competition produce up to the level of output where marginal cost = marginal revenue (MC=MR)
     

  • The firm can make abnormal profit in the short-run
     

  • The average revenue (AR) curve is the demand curve of the firm and it is downward sloping

    •  The firm has some market power due to the level of product differentiation that exists

      • To sell an additional unit of output, the firm will have to decrease its price

      • The marginal revenue (MR) curve will fall twice as quickly as the average revenue curve (AR)

  • A very good example of how this occurs can be seen in the barber shop industry 

    • Innovators may offer unique features such as free espressos, or child care while you wait

    • This permits them to charge higher prices until such a point as competitors copy their innovative actions

    • Their abnormal profit will then be eroded

Diagram: Short-run Profits for a Monopolistically Competitive Firm

3-4-3-supernormal-short-run-profit_edexcel-al-economics

Firms can make supernormal profits in the short-run as the AR > AC at the profit maximisation level of output (Q1)

 Diagram analysis

  • The firm produces at the profit maximisation level of output, where MC = MR (Q1)

    • At this level, AR (P1) > AC (C1)

    • The firm is making abnormal profit begin mathsize 14px style equals space left parenthesis straight P subscript 1 space minus space straight C subscript 1 right parenthesis space cross times space straight Q subscript 1 end style

Short-run Losses in Monopolistic Competition

  • Firms in monopolistic competition are able to make losses in the short-run

Diagram: Short-run Losses in Monopolistic Competition

3-4-3-short-run-losses_edexcel-al-economics

Short-run losses occur as AR (PE ) <  AC at the profit maximisation level of output (QE) 

Diagram analysis

  • The firm produces at the profit maximisation level of output, where MC = MR (QE)

    • At this level of output, the AR (PE) < ATC (C1)

    • The firm's loss is =space left parenthesis straight P subscript straight E space minus space straight C subscript 1 right parenthesis space cross times space straight Q subscript straight E

Long-run Normal Profit in Monopolistic Competition

From Abnormal to Normal Profit

  • If firms in monopolistic competition make abnormal profit in the short-run, new entrants are attracted to the industry, and the number of sellers increases

    • They are incentivised by the opportunity to make supernormal profit

    • There are low barriers to entry and It is easy to join the industry

  • Abnormal profit will be eroded, and the firm will return to the long-run equilibrium position of making normal profit

From Losses to Normal Profit

  • If firms in monopolistic competition make losses in the short-run, some will shut down

    • The shut down rule will determine which firms shut down

    • There are low barriers to exit, so it is easy to leave the industry

  • For the remaining firms, losses will be eliminated, and the firm will return to the long-run equilibrium position of making normal profit

Diagram: Long-run Equilibrium for a Monopolistically Competitive Firm

3-4-3-from-losses-to-normal-profit_edexcel-al-economics

The firm is making a normal profit. AR (P1) = AC at the profit maximisation level of output (Q1)

Diagram analysis

  • The firm is producing at the profit maximisation level of output, where MC=MR (Q1)

  • At this level of output, P1 = AC and the firm is making normal profit

  • In the long-run, firms in monopolistic competition always make normal profit

    • Firms making a loss leave the industry

    • Firms making supernormal profit see it slowly eradicated as new firms join the industry

Non-Price Competition

  • Firms competitive monopolistic markers engage in a wide range of non-price competition strategies

    • The aim is to increase product differentiation, develop or increase brand loyalty and increase market share

Non-Price Competition Strategies in Monopolistic Markets 

Strategy

Explanation


Location

  • Businesses can position shop in areas of high consumer traffic, convenience, and visibility

    • This increases accessibility and attracts potential customers

    • E.g setting up a nail bar in a busy shopping district 


Quality & customer focus

  • Delivering quality services, personalised consultations and tailored treatments to meet the unique needs and preferences of customers

    • E.g beauty salons give each customer a personalised experience 


Shop environment

  • Businesses can invest in visually appealing shop fronts and environments to differentiate from other businesses  

    • E.g Bars using stylish decor, comfortable seating and good music to attract customers 


Owner personality & store image

  • Using personal expertise of owner to establish a distinct identity and build a loyal customer base

    • E.g The owner of an organic bakery can deliver knowledge of nutrition using social media to cultivate image and attract customers


Word of mouth advertising

  • Businesses can ask customers to spread positive reviews and recommendations

    • E.g before-and-after transformations on social media, or asking for customer feedback for online 


Local marketing initiatives

  • Local businesses can sponsor local clubs to create brand visibility for local customer base 

    • E.g Paying for branded jerseys for local football club


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    Author
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    Lorraine

    Author: Lorraine

    Expertise: Economics Content Creator

    Lorraine brings over 12 years of dedicated teaching experience to the realm of Leaving Cert and IBDP Economics. Having served as the Head of Department in both Dublin and Milan, Lorraine has demonstrated exceptional leadership skills and a commitment to academic excellence. Lorraine has extended her expertise to private tuition, positively impacting students across Ireland. Lorraine stands out for her innovative teaching methods, often incorporating graphic organisers and technology to create dynamic and engaging classroom environments.

    Steve Vorster

    Author: Steve Vorster

    Expertise: Economics & Business Subject Lead

    Steve has taught A Level, GCSE, IGCSE Business and Economics - as well as IBDP Economics and Business Management. He is an IBDP Examiner and IGCSE textbook author. His students regularly achieve 90-100% in their final exams. Steve has been the Assistant Head of Sixth Form for a school in Devon, and Head of Economics at the world's largest International school in Singapore. He loves to create resources which speed up student learning and are easily accessible by all.