Production Games Monopolistic Competition Monopolistic competition arises when there are a large number of price-setting firms in an industry with free entry. Suppose there are n firms. In the short run, each firm faces an nth of the market demand (y) Short run analysis is not very different to that of the monopolist. The firm charges pfor an output of y"and makes T profit. The only difference demand is given by pn(y), an nth of total demand. However, in the long run other firms are free to enter if incumbents are making a profit or leave if they make a loss The Long run Firms will continue to enter until there is no incentive for further entry. That is, when profits are driven to zero. As more firms enter demand is reduced to each of the incumbent firms. Suppose once m firms are in the industry profits for each firm They will produce y each at a price of p'in the long run. Each firm is profit maximising, but receiving zero profit. They are average cost pricing. This is still inefficient. A perfectly competitive firm would produce at p= MC, which is a lower price and higher output.Production — Games 1 Monopolistic Competition • Monopolistic competition arises when there are a large number of price-setting firms in an industry with free entry. • Suppose there are n firms. In the short run, each firm faces an nth of the market demand curve. .................. ...... ............................ ................................................................................................................................................................................................................................................................................ . . . . . . . . . . . . ............ ............. ............. ............. ............ ............. ............. ............. 0 p y MC AC p ∗ y ∗ pn(y) MRn π • Short run analysis is not very different to that of the monopolist. The firm charges p ∗ for an output of y ∗ and makes π profit. The only difference is that demand is given by pn(y), an nth of total demand. • However, in the long run other firms are free to enter if incumbents are making a profit or leave if they make a loss. Production — Games 2 The Long Run • Firms will continue to enter until there is no incentive for further entry. That is, when profits are driven to zero. .................... ............................ ................................................................................................................................................................................................................................................................................ . . . . . . . ......... ............. ............. ............. ............. 0 p y AC MC p ∗ y ∗ pm(y) MRm • As more firms enter demand is reduced to each of the incumbent firms. Suppose once m firms are in the industry profits for each firm are zero. They will produce y ∗ each at a price of p ∗ in the long run. • Each firm is profit maximising, but receiving zero profit. They are average cost pricing. This is still inefficient. A perfectly competitive firm would produce at p = MC, which is a lower price and higher output