Pure monopoly and perfect competition are two extreme cases of market structure. In reality, there are markets having large number of producers competing with each other in order to sell their product in the market. Thus, there is monopoly on the one hand and perfect competition, on the other hand. Such a mixture of monopoly and perfect competition is called monopolistic competition. It is a case of imperfect competition.
The model of monopolistic competition describes a
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This means in the long run, a monopolistically competitive firm will make zero economic profit. This illustrates the amount of influence the firm has over the market; because of brand loyalty, it can raise its prices without losing all of its customers. This means that an individual firm's demand curve is downward sloping, in contrast to perfect competition, which has a perfectly elastic demand schedule.
Monopolistically competitive markets exhibit the following characteristics:
1. Each firm makes independent decisions about price and output, based on its product, its market, and its costs of production.
2. Knowledge is widely spread between participants, but it is unlikely to be perfect. For example, diners can review all the menus available from restaurants in a town, before they make their choice. Once inside the restaurant, they can view the menu again, before ordering. However, they cannot fully appreciate the restaurant or the meal until after they have dined.
3. The entrepreneur has a more significant role than in firms that are perfectly competitive because of the increased risks associated with decision making.
4. There is freedom to enter or leave the market, as there are no major barriers to entry or exit.
5. A central feature of monopolistic competition is that products are differentiated.