Monopolistic competition refers to a market situation with a relatively large number of sellers offering similar but not identical products. Examples are fast food restaurants and clothing stores.

1. A lot of firms: each has a small percentage of the total market.

2. Differentiated products: variety of the product makes this model different from pure competition model. Product differentiated in style, brand name, location, advertisement, packaging, pricing strategies, etc.

3. Easy entry or exit.

The firm’s demand curve is highly elastic, but not perfectly elastic. It is more elastic than the monopoly’s demand curve because the seller has many rivals producing close substitutes; it is less elastic than pure competition, because the seller’s product is differentiated from its rivals.

The MR = MC rule will give the firms the profit – maximizing output. The price they charge would be on the demand curve. In the long run, the situation will tend to be breaking even for firms. Firms can enter the industry easily and will if the existing firms are making an economic profit. As firms enter the industry, the demand curve facing by an individual firm shift down, as buyers shift some demand to new firms until the firm just breaks even. If the demand shifts below the break-even point, some firms will leave the industry in the long run.

Therefore, most monopolistic competitive firms should experience break-even in the long run theoretically. In reality, some firms experience profit as they able to distinguish themselves from the others and build a loyal customer base; such as some name brand apparel companies. Some firms experience lost in long run but may continue the business as they are still earning normal profit. These firm owners usually like the flexible life style and willing to earn a normal profit that is lower than their opportunity cost. 

Price exceeds marginal cost in the long run, suggesting that society values additional units which are not being produced. Average costs may also be higher than under pure competition, due to advertising cost involved to attract customers from competitors. The various types, styles, brands and quality of products offers consumers choices. However, economic inefficiency is the result. The excess capacity (producing at the quantity that a firm produces is less than the quantity at which ATC is a minimum) exists in this industry.

Efficiency

1. Productive efficiency: occurs where P= min ATC. Monopolistic competitive firms will not achieve productive efficiency as firms will produce at an output which is less than the output of min ATC. Product differentiation is the major cause of excess capacity.

2. Allocative efficiency: occurs where P = MC. This efficiency is not achieved because price( what product is worth to consumers) is above MC (opportunity cost of product).

Advertisement is very crucial for each firm in this market structure as firms need exposure to get consumer's attention. However, too much spending will result in higher cost, and lower profit. Price, product attributes, and advertisement are three main factors that producers have to consider. The perfect combination cannot be forecasted easily.