Chapter 13: Monopolistic Competition: Competitors, Competitors Everywhere for this product differentiation. For example, differences in product quality or the type of service performed can lead to differentiation. The firm’s location is another source of the differentiation. Finally, differentiation may result from interfirm differences in promotion and packaging. ✓ Easy entry and exit: A monopolistically competitive market has no barriers to entry. New firms can easily establish themselves in the market, and similarly, existing firms can easily exit the market. Typically, easy entry and exit occurs because monopolistically competitive firms have relatively small fixed costs, so existing firms don’t significantly benefit from lower per-unit production costs as compared to new firms.
Setting Price with Many Rivals Interfirm differentiation allows the monopolistically competitive firm to set price. Therefore, the firm determines both the profit-maximizing quantity and the good’s price. However, the degree of influence the firm has on price is limited because a large number of rival firms are producing similar products.
Recognizing the importance of product differentiation The degree of influence a monopolistically competitive firm has on the good’s price is dependent on the price elasticity of demand for the firm’s good. The more elastic the demand, the less influence the firm has on price, because quantity demanded is very responsive to any price change. Two factors that influence the monopolistically competitive firm’s price elasticity of demand are the number of firms, and the degree of product differentiation among firms. A large number of firms results in consumers having a greater number of alternatives from which to choose. Therefore, consumers are more responsive to price changes. If your firm increases price, your customers are more likely to switch to one of your rivals. As a consequence, with a larger number of rival firms, the demand for your firm’s good is more elastic and you have less influence over price. A small degree of product differentiation also results in consumers being less concerned about which firm they purchase the good from. If firms produce nearly identical products (that is, the products have very little differentiation), consumers are very responsive to any price changes that occur. Because the products are so similar, consumers simply look for the lowest price. This minimizes your firm’s ability to charge a higher price. If you
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