Monopolistic Competition

Monopolistic competition is Bertrand competition with differentiated products: each firm has some market power on its own demand curve and sets price taking rivals' prices as given. Topic 2 writes the inverse demand

where $g$ measures product similarity. Each firm derives a Best Response Function from $\partial \Pi_i / \partial P_i = 0$ and the intersection of best responses is the Nash Equilibrium.

When to use

Use monopolistic competition whenever you have many firms selling close but not perfect substitutes (toothpaste brands, restaurants, consumer electronics). It is the realistic compromise between the Bertrand paradox of homogeneous-good Bertrand and the integer-firm tractability of Cournot. The exam check: equilibrium markups are strictly positive ($L > 0$) and decline as $g \to 1$ (products become closer substitutes).