Why analyze a firm’s profit maximizing strategies under conditions of monopolistic competition?

This module explains monopolistic competition, the second example of imperfect, or real world, competition (along with oligopoly, which you studied in the previous module). Most of what you purchase at the retail level is from monopolistically competitive firms, so this model is relevant to most people’s lives.

Fast Food is the Best! by ebru, CC-BY.

Monopolistically competitive industries are those that contain more than a few firms, each of which offers a similar but not identical product.  Take fast food, for example. The fast food market is quite competitive, and yet each firm has a monopoly in its own product. Some customers have a preference for McDonald’s over Burger King. Some have a preference for Dominoes over Pizza Hut. These preferences give monopolistically competitive firms market power, which they can exploit to earn positive economic profits.

Consider the following questions:

• Why do gas stations charge different prices for a gallon of gasoline?
• What determines how far apart the prices of Colgate and Crest toothpaste can be?
• Why did fast food restaurants start offering salads?
• Why are fast food chicken sandwich prices different from burger prices?
• Why did McDonalds come up with the Big Mac sandwich?

In a real sense, the model of monopolistic competition is a combination of the models of perfect competition and monopoly. As you progress through this module, think about the similarities and the differences between monopolistic competition and those other two models of market structure.

LEARNING OUTCOMES

• Define the characteristics of a monopolistically competitive industry
• Calculate and graph the firm’s fixed, variable, average, marginal and total costs
• Explain the difference between short run and long run equilibrium in a monopolistically competitive industry
• Understand how product differentiation works in monopolistically competitive industries and how firms use advertising to differentiate their products, understanding impact on elasticity
• Understand why monopolistically competitive markets are inefficient (including deadweight loss)