1.5.4: Monopolistic Competition (HL only)



  1. Monopolistic competition is a market structure where there are many sellers producing differentiated products, with no barriers to entry or exit.
  2. Product differentiation is a form of non-price competition where suppliers attempt to make their products different (or perceived to be different) from those of their competitors.


Assumptions of the model

  • Made up of large no. of small firms.
  • All firms produce differentiated products.
  • No barriers to entry and exit.
  • Makes normal profits in the long run.


Product differentiation

  • Products are differentiated by brand name, color, appearance, packaging, design, quality of service, skill levels and other methods.
  • Examples include salons, car mechanics and jewellers.
  • Brand loyalty is important as firms takes risks, consumers still buy their products due to their image and reputation.
  • Brand loyalty → Firms are independent for pricing decisions → Price takers.


Movement from short run to long run in monopoly


1. Short term abnormal profit to normal profit

  • When firms make short-run abnormal profits → Others firms will come into the industry → Takes the business activity away from existing firms → Shifts demand curve to the left → Price and cost stays the same → Normal profits.


2. Short term losses to abnormal profit.

  • When firms make short-run losses → Firms in the industry starts to leave → Firms that remain will increase demand which should lead to increase in price, making price = cost → Normal profits for the firm.


Productive and allocative efficiency

  • Productive efficiency is where MC = AC.
  • Allocative efficiency is where MC = AR.

Advantages of monopolistic competition compared to perfect competition

  • Monopolies have large economies of scale because of their size
  • More variety of choice for consumers due to differentiated products.


Disadvantages of monopolistic competition to perfect competition

  • Productively and allocatively inefficient.
  • Charge a higher price for lower level of output.