Economics Monopolistic Competition Questions Medium
Monopolistic competition refers to a market structure where there are many firms selling differentiated products that are close substitutes for each other. In this type of market, each firm has some degree of market power, which is the ability to influence the market price of its product.
The impact of monopolistic competition on market power can be analyzed from two perspectives: the short run and the long run.
In the short run, due to product differentiation, each firm has some control over the price it charges for its product. This allows firms to have a certain level of market power, as they can set prices higher than their marginal costs. However, this market power is limited as there are close substitutes available in the market. If a firm tries to charge a significantly higher price, consumers can easily switch to a similar product offered by a competitor. Therefore, in the short run, monopolistic competition leads to a moderate level of market power for each firm.
In the long run, the impact of monopolistic competition on market power is reduced. This is because in the long run, new firms can enter the market and existing firms can exit. The ease of entry and exit in monopolistic competition allows for competition to intensify over time. As new firms enter the market, they introduce more substitutes for consumers to choose from, which reduces the market power of existing firms. Additionally, if a firm is earning economic profits in the short run, it will attract new entrants, leading to increased competition and a decrease in market power. Conversely, if a firm is incurring losses, it may exit the market, reducing competition and potentially increasing market power for the remaining firms.
Overall, monopolistic competition leads to a moderate level of market power in the short run, but this power diminishes in the long run due to the entry and exit of firms. The presence of close substitutes and the ability of consumers to switch between products limit the market power of individual firms, promoting competition and consumer welfare.