Question

How do the demand curves facing the perfectly competitive firm, the monopolist, and the monopolistically competitive firm differ? Explain why these differences arise.

Answer 1

Perfect Competition is a form of market structure in which there is free entry and exit of firms and firms are selling homogeneous and identical products in the market. Firms under this form of market are price takers rather than price makers. Demand curve of competitive market is perfectly elastic. It means that the firm can sell any amount of the commodity at the prevailing price. Firm's demand curve is indicated by a horizontal straight line parallel to X-axis. This shows that the firm is to accept the price as determined by the forces of market supply and market demand.

Monopoly is a form of market in which there exists only a single seller who sold goods which does not have close substitutes. There is barrier in the entry of new firms. Under monopoly, the firm is a price maker because it can fix the price for its product. It has free control over the supply of the product. A monopolist firm faces a market demand curve which is negatively sloped. It means that the firm will have to reduce the price to increase its sale. Demand curve of a firm under monopoly is less elastic because the product has no close substitutes.

Monopolistic competition refers to a market situation in which there are large number of buyers and sellers. The sellers sell closely related or differentiated products but not identical product. The products are close substitutes of each other. Product differentiation is the most important feature of monopolistic competition. Each firm under monopolistic competition enjoys the monopoly over the brand of the commodity and thus the firm has the control over the price of the commodity. Under monopolistic competition, demand curve slopes downwards but this curve is more elastic.