In a market structure known as monopolistic competition, numerous businesses compete with one another by providing unique items. Each company has some level of market strength and has some control over how much its product costs. Monopolistic competition, as opposed to ideal competition, allows for short-term financial success for businesses. However, as new businesses enter the market, earnings eventually tend to diminish. Nevertheless, are there entrance hurdles in monopolistic competition?
There are indeed entrance hurdles in monopolistic competition. The first obstacle is consumer brand loyalty. New businesses find it challenging to enter the market and draw in clients because established businesses already have a name and reputation. The high start-up costs are the second obstacle. To set their products apart from the competition, businesses must spend a lot of money on advertising and product development. For fledgling businesses with little resources, this can be a big hurdle.
Companies engaged in monopolistic competition can generate profits in the near term by setting prices above their marginal costs. Due to product differentiation, the demand for their product is comparatively inelastic. Long-term demand for the products of established enterprises will decline as a result of increased competition brought on by the introduction of new firms. Profits will consequently decline, forcing businesses to slash their pricing.
A monopolistic competitor will select the amount of output where marginal revenue equals marginal cost in order to maximize profits. In contrast to ideal competition, the firm’s market strength will cause the price to be greater than the marginal cost. In the long run, as more businesses enter the market and competition rises, the amount of output that maximizes profits will decline.
The demand curve of an existing firm will move to the left when new firms enter a monopolistically competitive market. This is so that there will be less demand for the products offered by the established firm because new businesses will supply comparable goods. As a result, in order to keep its market share, the established company will have to cut its pricing. The established company’s profit margin will, however, decline as a result of the price reduction.
Finally, monopolistic competition has entry-level obstacles including strong brand loyalty and high startup expenses. Businesses under monopolistic competition may be profitable in the short term, but as new competitors enter the market, profits will eventually decline. A monopolistic competitor will select the production quantity where marginal revenue and marginal cost are identical in order to maximize profits, but the price will be greater than the marginal cost due to market power. In order to keep their market share, incumbent businesses will be forced to drop their prices as a result of the introduction of new competitors.
When the average total cost curve (ATC) is higher than the average revenue curve (AR) at the output level that maximizes profits, monopolistic competition results in a loss for the firm. This indicates that the firm is not charging a price that is high enough to pay all of its expenses.
The short-run equilibrium of a monopolistic competition firm can be represented by the following graph:
The graph’s downward-sloping demand curve (AR) illustrates the firm’s competitive market environment. Because the firm’s output choices have an impact on the market price, the marginal revenue (MR) curve of the firm is lower than the demand curve. By producing at the output level where MR=MC, symbolized by the red dot, the company maximizes its profitability.
At this level of output, the firm’s average total cost (ATC) curve, however, is higher than the demand curve. As a result, the company experiences a loss equal to the shaded region (price minus average total cost multiplied by output), which is the result of charging a price that does not fully cover its costs.
In the long run, if a company cannot make a profit, it may leave the market, which could result in fewer enterprises and more market power for the ones that remain.