ABSTRACT
This chapter focuses on the case of monopolistic competition. In a monopolistically competitive market, there are many firms selling slightly differentiated products. Product differentiation means that there is no perfect alternative to any one product available for sale in the market. A monopolistically competitive market has the following characteristics: Many buyers and sellers; Product differentiation; and Free entry and exit. The chapter considers the profit-maximizing choice of a firm in monopolistic competition. Monopolistic competition sits between the two extremes of perfect competition and monopoly. A firm in monopolistic competition is a price maker–like a monopolist–using its market power to set price greater than marginal cost. Like in a competitive industry, there is free entry and exit in the long run, driving profits over the longer term to zero. The welfare implications of monopolistic competition are somewhat ambiguous.
