M9: MONOPOLISTIC COMPETITION

• MONOPOLISTIC COMPETITION consists of:

  • Relatively Large Number of Sellers
  • Differentiated Products
  • Easy Entry and Exit
• Relatively Large Number of Sellers

  • Monopolistic competition is characterized by a fairly large numbers of firms.
• The relatively large number of sellers is consequently involved with:

  • Small market share
  • No collusion
  • Independent action
• Small market share => each firm has a comparatively small percentage of the total market and consequently has limited control over market price.
• No collusion => the presence of a relatively large numbers of firms ensures that collusion by a group of firms to restrict output and set prices in unlikely.
• Independent action => each firm can determine its own pricing policy without considering the possible reactions of rival firms.
• THE FOLLOWING CONSISTS OF DIFFERENTIATED PRODUCTS:

  • Product attributes
  • Service
  • Location
  • Brand names and packaging
  • Some control over price
• Easy Entry and Exit

  • Small firms
  • Capital Requirements are low
  • Economies of scale are few
  • Nothing prevents an unprofitable monopolistic competitor from holding a going-out-of-business sale and shutting down
• Advertising => is the expense and effort involved in product differentiation would be wasted if consumers were not made aware of product differences.
• Nonprice Competition

  • It is the goal of product differentiation and advertising.
  • It is to make price less of a factor in consumer purchases and make product differences a greater factor. If successful, the firm’s demand curve will shift to the right and will become less elastic.
• ASSUMPTIONS of Price and Output in Monopolistic Competition:

  • Each firm in the industry is producing a specific differentiated product
  • Each engage in a particular amount of advertising
• The Firm's Demand Curve

  • The demand curve faced by a monopolistically competitive seller is highly, but not perfectly, ELASTIC.
  • It is precisely this feature that distinguishes monopolistic competition from pure monopoly and pure competition.
  • The price elasticity of demand faced by monopolistically competitive firm depends on the number of rivals and the degree of product differentiation.
• The Short Run: Profit or Loss

  • The monopolistically competitive firm maximizes its profit orminimizes its loss in the short run by producing the output at MR=MC.
• The Long Run: Only a Normal Profit

  • Firms will enter a profitable monopolistically competitive industry, and leave an unprofitable one. So a monopolistic competitor will earn only a normal profit in the long run or; in other words, will only break even.
• COMPLICATIONS OF MONOPOLISTIC COMPETITION:

  • Some firms may achieve sufficient product differentiation such that other firms cannot duplicate them, even over time.
  • Entry to some industries populated by small firms is not as free as it is in theory.
  • With all things considered, however, the outcome that yields only a normal profit, the long-run equilibrium is a reasonable approximation of reality.
• EFFICIENCY OF MONOPOLISTIC COMPETITION:

  • Economic efficiency requires the triple equality
  • P = MC = minimum ATC.
• Excess Capacity

  • In monopolistic competition, the gap between the minimum ATCoutput and the profit-maximizing output identifies excess capacity.
  • It is the plant and equipment that are underused because firms are producing less than the minimum ATC output.
• The product variety and product improvement that accompany thedrive to maintain economic profit in monopolistic competition are abenefit for society – one that may offset the cost of the inefficiencyassociated with monopolistic competition.
• Product differentiation creates a trade-off between consumer choiceand productive efficiency. The stronger the product differentiation,the greater is the excess capacity.
• The greater is the excess-capacity problem, the wider the range of consumer choice.
• The efficiency loss (deadweight loss) associated with monopolistic competition is greatly muted by the benefits consumers receive from product variety.