Pricing under Monopolistic Competition

Economics >> Pricing under Monopolistic Competition

As a result of product differentiation, customers tend to build brand loyalty so that competing firms have some control over the price. Because competing products are close substitutes, demand is relatively elastic, but not perfectly elastic, as in perfect competition. The firm has some discretion in raising price without losing its entire market to competitors. Conversely, lowering price will induce additional (but not unlimited) sales. In the short run, the seller can increase the price slightly if there are a number of producers with close substitutes. Similarly, a small decrease in price can attract more customers. Sales can also be increased through advertisement and by undertaking sales promotion techniques.

Short run: short run equilibrium of a monopolistically competitive firm.
Long run: In the long run, free entry and exit ensures that all firms earn zero economic profits. New firms will enter industry attracted by the economic profits. The firm will share the market with greater number of competitors; therefore, the demand curve for the product of individual firm will shift downwards. For example, the success of video outlets in a community may entice other firms to provide the service. With this entry, the market share of existing firms decreases. Theory of managerial economics readmore

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