Under monopolistic competition, a market structure is characterized by many firms selling differentiated products. The Demand Curve in monopolistic competition is downward sloping, reflecting the negative relationship between price and quantity demanded. It faces a more elastic demand curve due to product differentiation, allowing some degree of pricing power. Each firm faces its own demand curve, which can be shifted through successful product differentiation or advertising.
Marginal Revenue (MR) is the additional revenue a firm earns by selling one more unit of its product. In monopolistic competition, the MR curve lies below the demand curve to sell more units. The firm must lower the price, which applies to all units sold. As a result, the revenue gained from selling additional units diminishes.
Marginal Cost (MC) represents the additional cost of producing one more output unit. The curve initially decreases and then increases, forming a U-shape due to the law of diminishing returns. As production increases, the cost of producing each additional unit rises.
In summary, under monopolistic competition, firms' ability to set prices and earn profits is influenced by the interaction of MR, MC, and the demand curve, all of which are shaped by the degree of product differentiation and market competition. This framework helps explain why firms in these markets engage in non-price competition and why they may operate with excess capacity in the long run.
