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Monopolistic Competition • A market with many buyers and sellers, with low barriers to entry and differentiated products • Each seller creates a certain uniqueness and brand loyalty within a largely competitive market • Each seller can charge a slightly different price (Perfect competition assumes homogeneity of products. Monopolistic Competition is a more likely model under which most business operate, particularly manufactured goods.) Monopolistic Competition – The Curves in the Long Run! Price £ MC AC P profit max MR Q profit max AR = D Quantity Profit maximising output is where MC = MR Price for this output is set by the demand / AR curve This diagram shows no abnormal profit since AC = P Short Run Long Run Price £ Price £ MC MC AC AC AC P profit max P MR Q profit max AR = D MR AR = D Q Quantity profit max Quantity In the short run, firms may make a loss (AC > AR) so firms will leave the industry. This reduces the advertising costs (AC) and increases the market size (AR) of existing firms to return to normal profits Short Run Long Run Price £ Price £ MC MC AC AC P profit max P AC MR Q profit max AR = D Quantity MR AR = D Q profit max Quantity In the short run, firms are may make supernormal profits (AC < AR) so new firms will enter the industry. This increases advertising costs (AC) and decreases market size (AR) of existing firms to return to normal profits. Monopolistic Competition Efficiency Allocative Efficiency Since P ≠ MC; (P>MC) Productive Efficiency Q is not at min AC. Evaluating the Monopolistic Competition Model • Model assumes freedom of entry/exit – the extent of this may differ by industry • New products may mimic some existing products more than others – so some firms may be squeezed out while others maintain super-normal profits