Chapter 25, Problem 25.1LO

To determine

To Explain:

Key characteristics of a monopolistically competitive industry.

Concept Introduction:

Monopolistically Competitive Industry: Monopolistically competitive industries are the industries which have many firms and they offer similar or differentiated products and not a homogeneous or identical product.

Explanation of Solution

Key characteristics of a Monopolistically Competitive Industry

• Many firms: There are large number of buyers and sellers in a monopolistically competitive industry. This implies that each firm is having a larger number of competitors. Each firm is comparatively small considering the market size. This guarantees a competitive environment in the market with less control on price or quantity.

• No Barrier of entry or exit: It is easy for any firm to enter or exit this industry. The barrier of entry or exit is low. If there is supernormal profit in the market, new firms will enter. This will lead to an increase in the supply and thus reduce the price. The firms will now realize only normal profit. Similarly with sustaining losses, some firms will exit which will reduce the supply and increase price. So the existing loss will turn to normal profits.

• Differentiated Product: The firms sell differentiated products which are similar to each other but not identical. They are not perfect substitutes. Each product is slightly different from each other. This is known as product differentiation. Each firm in monopolistic market claims their product to be exclusive from the other. This gives them slight monopoly power and so they have a negatively sloped demand curve. Products are generally differentiated based on three categories.

1. Physical differences
2. Perceived differences
3. Differences in supports services

• Price maker: Monopolistically competitive firms are price makers and not price takers. They intent to set their own price. Each firm claims to produce a unique product, so they can set the price of their own product. They need to take the industry set price. They can just follow it as a guideline. Thus they have a downward sloping demand curve.