SUMMARY

1. Monopolistic competition is a market structure in which there are many competing producers, each producing a differentiated product, and there is free entry and exit in the long run. Product differentiation takes three main forms: by style or type, by location, or by quality. Products of competing sellers are considered imperfect substitutes, and each firm has its own downward-sloping demand curve and marginal revenue curve.

2. Short-run profits will attract entry of new firms in the long run. This reduces the quantity each existing producer sells at any given price and shifts its demand curve to the left. Short-run losses will induce exit by some firms in the long run. This shifts the demand curve of each remaining firm to the right.

3. In the long run, a monopolistically competitive industry is in zero-profit equilibrium: at its profit-maximizing quantity, the demand curve for each existing firm is tangent to its average total cost curve. There are zero profits in the industry and no entry or exit.

4. In long-run equilibrium, firms in a monopolistically competitive industry sell at a price greater than marginal cost. They also have excess capacity because they produce less than the minimum-cost output; as a result, they have higher costs than firms in a perfectly competitive industry. Whether or not monopolistic competition is inefficient is ambiguous because consumers value the diversity of products that it creates.

5. A monopolistically competitive firm will always prefer to make an additional sale at the going price, so it will engage in advertising to increase demand for its product and enhance its market power. Advertising and brand names that provide useful information to consumers are economically valuable. But they are economically wasteful when their only purpose is to create market power. In reality, advertising and brand names are likely to be some of both: economically valuable and economically wasteful.