Q.Explain the main features of monopolistic competition. Why does a firm under monopolistic competition end up with 'excess capacity' in the long run?
You're viewing a preview — the full solution, concept, methods & PYQ mapping are locked.
Start your 14-day free trial to unlock the full solution →Monopolistic competition has: a fairly large number of sellers; a differentiated product, where rival firms sell close-but-not-identical substitutes distinguished by brand, packaging, or quality; free entry and exit of firms in the long run; and significant selling costs (advertising, promotion) used to build and defend each firm's brand.
Because products are differentiated, each firm faces its own downward-sloping (though fairly elastic) demand curve, rather than the horizontal demand curve of perfect competition. A firm sets output where , as always.
In the long run, free entry means that any super-normal profit attracts new firms selling similar (substitute) products, which shifts each existing firm's demand curve inward until only normal profit remains — similar in spirit to perfect competition. But the shape of the equilibrium differs: because each firm's demand curve still slopes downward (unlike the horizontal curve of perfect competition), the long-run equilibrium output occurs where this downward-sloping demand curve is tangent to the average-cost curve — and a tangency to a U-shaped AC curve from a downward-sloping line necessarily happens somewhere on the falling part of the AC curve, to the left of its minimum point. …
Unlock everything free for 14 days
- Full step-by-step solutions
- Concept-first explanations
- Methods, shortcuts & mistakes
- PYQ mapping + timed mock tests
Full access for 14 days. No credit card required.