Cambridge International as and a level Economics Ebook

The market and change: 
The idealistic model of perfect 
competition is the most eff icient in the long run. All other 
market structures are ineff icient to varying degrees.
KEY CONCEPT LINK
TOP TIP
Perfect competition is sometimes called total 
competition.
164
Cambridge International A Level Economics

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Monopolistic competition
Th
is is the market structure closest to the model of perfect 
competition because of the large number of competing 
suppliers.
Monopolistic competition has the following 
characteristics:
■
There is a large number of buyers and sellers.
■
There are few barriers to entry into the market and it is easy 
for firms to recoup their capital expenditure on exit from 
the market.
■
Consumers face a wide choice of diff erentiated products. 
Each firm has a slight degree of monopoly power in that 
it controls its own brand through quality and physical 
diff erences.
■
Firms have some influence on the market price and are 
therefore price makers.
Each fi rm is competing with a large number of similar 
producers. In this situation the demand curve facing the 
individual fi rm will be downward-sloping but relatively 
price elastic because of the presence of substitutes. It is an 
option for fi rms to reduce their price in order to increase 
total revenue. As in perfect competition, the fi rms can 
make abnormal profi t in the short run but the key restraint 
on their power is the free entry of rivals. In the long 
run, profi t-maximising fi rms will only be able to achieve 
normal profi t covering all the production costs and the 
opportunity cost of capital.
Th
e clue to the behaviour of fi rms in this market 
structure lies in the concept of product diff erentiation. 
Th
e development of a strong brand image must be seen 
as an act of investment on the part of the individual fi rm. 
Th
is highlights the important role that advertising and 
promotions play in this market structure. Successful 
advertising will not only shift the fi rm’s demand curve 
to the right at the expense of rivals but will also reduce 
the price elasticity of demand if the consumers feel there 
are no close substitutes. Th
is is what is meant by brand 
loyalty – people will not easily shift back to rival products. 
Th
ere are problems associated with advertising because 
it is a competitive tool taken up by all fi rms. One could 
argue that the advantage will be temporary and that 
advertising will simply add to the fi rm’s costs and bring 
little benefi t to its demand curve. If advertising is not 
eff ective for all fi rms, those who are successful might take 
advantage of their greater market share and brand loyalty 
to charge a higher price. Th
ese fi rms would increase their 
sales revenue and by doing so move to the portion of the 
demand curve where price elasticity of demand has a value 
less than 1, i.e., inelastic.
It is easy to see how each fi rm can try to strengthen its 
market power in the short run. Th
e constraint on fi rms is