Monopolistic competition is a market structure that lies between perfect competition and monopoly. It arises in an indrusty in which:
  1. A large number of firms compete with each other.
  2. Each firm produces a differentiated product.
  3. Firms are free to enter and exit the market.
The big difference compared to perfect competition is that the firms are making slightly different products compared to the competing firms. This results in the firms having an element of monopoly power. The differences are often only in packaging and brand name. Since there are alot of firms competing in the same market no firm can effectively influence what other firms do. If one firm changes its price, it has no effect on the other firms.

Unlike perfect competition, a firm in monopolistic competition faces a downward-sloping demand curve. This is due to the fact that the products are differentiated; some people will pay more for one variety of the product. Because the firm faces a downward-sloping demand curve it maximizes profit by choosing both its price and its output. This is done in the same way as in monopoly, e.g. the firm produces the quantity where marginal cost (MC) and marginal revenue (MR) meet.

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