Question

explain monopolistic competition. It is suggested that one way to get into a monopolistically competitive market is to get a franchise for a nationally advertised product. Provide an example of a franchise and indicate how this is a monopolistically competitive situation based on your definition.

Answer 1

Monopolistic competition is a market structure in which there are a large number of buyers and sellers, selling differentiated products that are substitutes for each other.

Characteristics of monopolistic competition:

1. Independent price and output decisions by each firm

2. Freedom to entry and exit in the market, and hence no trade barriers. Thus the firms earn normal profits in the long run.

3. Differentiated products enable the firm to be a price setter for its product, and thus each firm faces a downward-sloping demand curve

4. There are a large number of independent firms competing in the market

A franchise is considered as a monopolistic competitive firm. This is because entering a market with a franchise, say like Dunkin donuts, provides brand recognition, advertising, and training to the firm. In return, the franchise holder gets a fixed fee and a percentage of sales revenue. The holder can earn supernormal profit in the short-run. However, there are no barriers to entry of other firms in opening a Dunkin donut franchise. And as a result, if other firms enter the market, the firm will start earning zero economic profits.