Market Power & Monopolistic Competition (DP IB Economics)

Revision Note

Test yourself
Steve Vorster

Written by: Steve Vorster

Reviewed by: Jenna Quinn

Characteristics of Monopolistic Markets

  • Market power refers to the ability of a firm to influence and control the conditions in a specific market, allowing them to have a significant impact on price, output, and other market variables
     

  • Firms in monopolistic competition have some market power, a slightly higher market share than perfect competition and a low industry concentration ratio
       

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

The level of market power is relatively low in monopolistic competition
    

  • 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 veg stores

 

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

 

 

  • There is some market failure in monopolistic competition, especially in the short run when firms are making abnormal profits

 

A side by side Comparison of Monopolistic Competition and a Monopoly

  • The diagrams are essentially the same, however the monopoly revenue curves are steeper (more inelastic)

The diagram on the left is a monopoly diagram as it has steeper revenue curves and is making abnormal profits

The diagram on the left is a monopoly diagram as it has steeper revenue curves and is making abnormal profits

 

Diagram Analysis

  • The monopoly market on the left has steeper revenue curves as the demand for the product is price inelastic

    • There are few or no substitute products 

    • This market is also making abnomal profit in the long run (P > ATC) at profit maximisation level of output (Q1)
       

  • The monopolistic market on the right has shallower revenue curves as the demand for their product is more price elastic

    • There are a large number of substitute products

    • The market is making normal profit in the long run (P = ATC) at the profit maximisation level of output (Q1)

Abnormal Profit in Monopolistic Competition in the Short-run

  • 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 AR
         

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

A diagram illustrating a monopolistically competitive firm making abnormal profit 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 the 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

Losses in Monopolistic Competition in the Short-run

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

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

A diagram illustrating a monopolistically competitive firm making losses in the short-run as the 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 =begin mathsize 14px style 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 end style

Normal Profit in Monopolistic Competition in the Long-run

From Abnormal to Normal Profit

  • If firms in monopolistic competition make abnormal profit in the short-run, new entrants are attracted to the industry & 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 & 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 & the firm will return to the long-run equilibrium position of making normal profit

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

A diagram illustrating the long-run equilibrium position for a monopolistically competitive firm which is making 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 & 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

Efficiency in Monopolistic Competition

  • Due to the more competitive environment, there are higher levels of efficiency in monopolistic competition than in other forms of imperfectively competitive market structures

    • This is true even when they are making abnormal profits in the short-run

      • There are also more products/services available for customers

    • In the long run, there are even higher levels of efficiency
       

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

Efficiency in Monopolistic Competition in the Long-run
  

Diagram Analysis

  • The firm produces at the profit maximisation level of output where MC=MR

  • The firm is not productively efficient as AC > MC at this level of output 

    • Productive efficiency would occur where MC=AC

  • The firm is not allocatively efficient as AR (P) > MC at this level of output

    • Allocative efficiency would occur where AR=MC

Last updated:

You've read 0 of your 10 free revision notes

Unlock more, it's free!

Join the 100,000+ Students that ❤️ Save My Exams

the (exam) results speak for themselves:

Did this page help you?

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.

Jenna Quinn

Author: Jenna Quinn

Expertise: Head of New Subjects

Jenna studied at Cardiff University before training to become a science teacher at the University of Bath specialising in Biology (although she loves teaching all three sciences at GCSE level!). Teaching is her passion, and with 10 years experience teaching across a wide range of specifications – from GCSE and A Level Biology in the UK to IGCSE and IB Biology internationally – she knows what is required to pass those Biology exams.