Monopolistic Competition

Learning Objectives:

• What is Monopolistic Competition?

• How is it different from Perfect Competition or Monopoly?

• How does a monopolistically competitive firm maximize its profit?

• What is the long run outcome of a monopolistically competitive market?

• What is product differentiation?

Features of a Monopolistically Competitive Market

• Many buyers and sellers

• Firms are producing similar but not perfectly identical products

• Buyers can differentiate among products sold by different firms

• There is free entry and exit

• Example: Jewelry market

• Example: Toothpaste market

Profit Maximization for a Monopolistically Competitive Firm

• Profit maximization rule:• Marginal Revenue (MR) = Marginal Cost (MC)

Profit = Total Revenue – Total Cost

Maximizing profit with respect to output:

Long Run Equilibrium in a Monopolistically Competitive Market

• In the Long Run, for a monopolistically competitive firm:

Product Differentiation or the Widening of Choice

• Comparative Advertising

• Brand value of a product

• Targeted or niche marketing

• R&D

Brand Myopia

• Successful product differentiation leading to lack of innovation and change in the firm

• Example: Blackberry

• Example: Nokia

• Example: Maggi

Optimal Advertising

• Profit maximizing advertising-to-sales ratio:

where A is advertisement spending for the product (Q), R is total revenue or sales from the product (Q), is the advertising elasticity of demand, and is the own price elasticity of demand for the product (Q).