Monopolistic competition

Further work on monopolistic competition was undertaken by Dixit and Stiglitz who created the Dixit-Stiglitz model which has proved applicable used in the sub fields of international trade theory, macroeconomics and economic geography.

This illustrates the amount of influence the company has over the market; because of brand loyalty, it can raise its prices without losing all of its customers.

In technical terms, the cross price elasticity of demand between goods in such a market is large and positive.

For example, a company could cut prices and increase sales without fear that its actions will prompt retaliatory responses from competitors.

It will reduce the supply due to which price would rise and the existing firms will be left only with normal profit.

[12] The theory is that any action will have such a negligible effect on the overall market demand that an MC company can act without fear of prompting heightened competition.

[13] Market power also means that an MC company faces a downward sloping demand curve.

In the long run, the demand curve is highly elastic, meaning that it is sensitive to price changes, although it is not completely "flat".

The first source of inefficiency is that, at its optimum output, the company charges a price that exceeds marginal costs.

The monopoly power possessed by a MC company means that at its profit-maximising level of production, there will be a net loss of consumer (and producer) surplus.

Both an MC and PC company will operate at a point where demand or price equals average cost.

For a PC company, this equilibrium condition occurs where the perfectly elastic demand curve equals minimum average cost.

Monopolistically-competitive markets are also allocative-inefficient, as the company charges prices that exceed marginal cost.

In either case, a successful advertising campaign may allow a company to sell a greater quantity or to charge a higher price, or both, and thus increase its profits.

In a monopoly market, the consumer is faced with a single brand, making information gathering relatively inexpensive.

In a monopolistically competitive market, the consumer must collect and process information on a large number of different brands to be able to select the best of them.

Short-run equilibrium of the company under monopolistic competition. The company maximises its profits and produces a quantity where the company's marginal revenue (MR) is equal to its marginal cost (MC). The company is able to collect a price based on the average revenue (AR) curve. The difference between the company's average revenue and average cost, multiplied by the quantity sold (Qs), gives the total profit. A short-run monopolistic competition equilibrium graph has the same properties of a monopoly equilibrium graph.
Long-run equilibrium of the firm under monopolistic competition. The company still produces where marginal cost and marginal revenue are equal; however, the demand curve (MR and AR) has shifted as other companies entered the market and increased competition. The company no longer sells its goods above average cost and can no longer claim an economic profit.