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Intermediate Microeconomics

11. Monopolistic Competition

Firms in monopolistically competitive markets have features of both monopolies and competitive firms. Given that monopolistically-competitive firms sell goods that are differentiated from those of their competitors, they face a downward-sloping demand curve, which allows them to charge a price that is above their marginal cost. The aspect of a monopolistically competitive market that is consistent with a competitive market is the fact that there are no barriers to entry. As such, whenever a firm is earning economic profit, there is an incentive for other firms to enter that market by producing a similar but differentiated version of the good. As a result, the monopolistically-competitive equilibrium requires that firms in an industry earn zero economic profit. Monopolistic competition is a prevalent form of industry structure. However, such an industry structure is difficult to analyze in the abstract, as we have done with competitive and monopolistic firms. It is often the case that the particular aspects of the products and available technologies matter a great deal when analyzing monopolistically competitive industries. There are a few interesting features, however, that we can cover, including a characterization of the monopolistically-competitive equilibrium and how economic profit prompts entry and results in a new monopolistically-competitive equilibrium.

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Monopolistically Competitive Equilibrium

This Pencast lists and describes the required conditions for a monopolistically competitive equilibrium. In addition, we illustrate with a graph the monopolistically competitive equilibrium. [Play Pencast]

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Economic Profit and Free Entry

This Pencast illustrates how an economic profit opportunity induces entry into an monopolistically competitive industry. It is also demonstrated that when a new firm or firms enters a monopolistically competitive industry that the demand curve facing a representative firm in the industry shifts and becomes more elastic. Entry continues until each firm is charging a price that equals its average total cost. [Play Pencast]

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