When we looked at the perfect competition

we said that firms are price takers.

They don't get to set the price

of their product.

They have to charge

whatever price is generated in the market

by a supply and demand,

but that doesn't really rings true

for many products.

We have this intuition

that for many goods

the producers do control

the prices they charge.

That's because

many of the things consumers buy

are produced by firms

that are monopolistic competitors.

Here's the key difference

between perfect competition

and monopolistic competition.

If the product is exactly the same

no matter which firm produces it,

the market will be perfectly competitive

but if each firm

makes a slightly different version

of that product

then the market will be

monopolistically competitive.

For example, consider bushels of wheat,

or barrels of oil,

or computer memory chips.

A barrel of oil

produced by one company is identical

to a barrel of oil produced by another.

A bushel of wheat produced by one farmer

is identical to wheat grown by another farmer.

Since there is no difference among producers,

a buyer won't pay a penny more

than the market price

and the producers

won't sell for a penny less

than the market price.

So in perfect competition

producers are price takers

but consider goods like

restaurant meals or movies.

Each producer is offering a product

that is unique

even if there are many competitors.

If you want to eat a meal

at Oscar's Octopus Hut,

you need to go to Oscar's.

If you want to watch

the next BadMan movie

your money will ultimately go

to BadMan studios.

So Oscar's essentially has a mini monopoly

on Oscar's meals

and BadMan studios has a mini monopoly

on BadMan  movies,

but since there are close substitutes

you can always go to Ellen's Eel Shack

instead of Oscar's

or watch the next Aluminum Man movie.

That means that each firm faces

a downward sloping demand curve

for its product.

If Oscar raises the price

of his Octopus meals

he will lose customers to Ellen.

While he would gain customers

if he cut his price.

The same dynamic is at work for BadMan studios

and their movies.

How does that show up in graphs?

Here is a firm

in a perfectly competitive market

and here is a

monopolistically competitive firm.

The perfectly competitive

from basically faces

a horizontal demand curve.

Since its product is identical

to everybody else's

it will lose all of its customers

if it charges one penny

above the market price.

On the other hand,

the monopolistically competitive firm

will lose some of its customers to competitors

if it raises its price

but some people will stay

because they really like the unique product

it's producing;

Octopus or BadMan movies.

That gives the

monopolistically competitive firm

a downward sloping demand curve.

Each firm maximizes profits

by producing at the quantity

where marginal cost

equals marginal revenue.

In the perfectly competitive case

marginal revenue

is just a fancy word for price.

In the monopolistically competitive case

the marginal revenue

is a function of the demand curve

just as with regular monopolies.

An increase in demand

in the perfectly competitive case

will simply raise the price

and the perfectly competitive firm

will move along its marginal cost curve

and increase output.

An increase in demand

for a monopolistically competitive firm

will actually be a shift out

for that firm's own mini demand curve.

How are perfectly competitive

and monopolistically competitive

markets similar?

In both cases

firms earning positive profits

will attract competitors in the long-run

since there is free entry.

Those competitors will bid down prices

until economic profits are zero.

However, there are also

important differences.

In the long-run

perfectly competitive markets

settle at the lowest possible production cost

but monopolistically competitive markets

won't push prices

all the way down to the lowest possible cost,

and monopolistically competitive markets

will have a smaller equilibrium output

than a perfectly competitive market

with the same technology

and the same number of firms.

So monopolistically competitive markets

are sort of like

perfectly competitive markets

because firms can enter

and drive down prices and profits

but they're also different

because each firm is producing

a slightly different product

and they end up

with higher costs and lower output

than we see

in perfectly competitive markets.