Monopolistic Competition

Presented By:

Group 11Shreyans Jain(257/2012)Jaideep Singh Drall(201/2012)Deepraj Pathak(258/2012)Rishi Pathak(254/2012)Praveen Lamba(248/2012)Kuldeep Singh(259/2012)

To explain Monopolistic Competition

To discuss prominent models of Monopolistic Competition

To analyze two academic cases of Monopolistic Competition

Business organizations or firms main motive is wealth maximization and to earn more profits and market share.

Depends on price, product, promotion as well as on competition.

Firms should know about its competitive environment and should study its market structure.

Market structure refers to a no. of factors i.e. the number of firms producing similar products, the degree of similarity, cost and entry-exit conditions.

Product group is the group of firms whose products are similar to one other and have interwoven market.

Similarity can be economic and technological.

Perfect: Market which has large suppliers and consumers selling identical products.

Monopoly: Market where there is only one firm which has whole market share.

Oligopoly: Market where there are small no. of firms but they have large market share.

Market where there are large no. of firms which sell differentiated products which are close substitutes but not identical.

Large number of sellers Free entry and exits for firms Product differentiation Selling costs

Features Perfect Monopolistic

Oligopoly Pure Monopoly

No. of Sellers

Large Many Few One

Products Homogenous

Differentiated Homogenous Differentiated

No close substitutes

Entry /Exit Free Free Strong Barriers to entry

Entry difficult

Size of sellers

Very small Small Large Small or large

Control over Price

No control Some Control Some control Total control

Degree of monopoly

power

Nil Limited Considerable Price makers

10

Price

Quantity 0

(a) Firm makes profit

Profit

MC

ATC

Profit-maximizing

quantity

ATC

(b) Firm makes losses

MR

Demand

Price

Price

Quantity 0

Losses

MC ATC

Loss-minimizing

quantity

ATC

MR

Demand

Price

Short Run Equilibrium with Normal Profits

Perceived Demand Curve :

Shows the demand for the product of one firm on the assumption that prices of products of other firms are constant.

Proportionate Demand Curve :

Shows the demand of the product of the firm when all firms in the product group change their prices simultaneously.

Perceived And Proportionate Demand Curve

Equilibrium with Price Competition Equilibrium with Entry of New Firms

Theory of Monopolistic Competition 1933

Each producer faces competition from "substitute" products which are not identical and which are sold by other concerns with various price policies and sales

Firms have monopoly over their own brands but there are many close substitutes

Selling costs are not part of the cost of production, but are incurred to increase the sales of the given product.

Monopolistic Competition need not bring higher profits to the marginal firm in a given industry, instead it may allow the existence of a larger number of firms making normal profits.

Chamberlain questioned belief that markets could only be perfectly competitive or monopoly based.

The theory of Imperfect Competition (1933) Introduction of marginal revenue curves Deals with an individual firm assuming the firm has its

own market and faces a downward sloping demand curve

Considers Monopoly and pure competition as mutually exclusive.

MR curve plays a vital role because of its definite relationship with price and elasticity.

Difference between price and MR at an output depends upon the magnitude of elasticity of demand.

Under perfect competition, P=MR [E=Infinite] Under Imperfect competition, P>MR Difference between price and MR at equilibrium output

is regarded as degree of imperfection.

AR= average revenueMR=marginal revenueα=marginal cost B= average cost OM=monopoly outputOQ=competitive outputDQ=competitive pricePM=monopoly priceC=intersection of marginal revenue and marginal cost

Blend of perfect competition and monopoly.

Consider product differentiation.

Greater emphasis on product variation and magnitude of selling cost.

Mutually exclusive theory.

Does not consider product differentiation.

No emphasis on product variation and magnitude of selling cost.

Discusses oligopoly in detail and provides solution.

Perfect competition can never represent wealth ideal due to heterogeneity and demand variation.

Neglected the discussion on oligopoly.

Based on assumption that products are homogeneous and demand variation is unimportant, Robinson considered pure competition as ideal.

Benchmark monopolistic competition model given in 1977

Utility function depends on numeraire commodity of a given industry or sector

Each firm must face fixed set-up cost & has a constant marginal cost

Each firm produces a different commodity

Number of firms is reasonably large and impact of other firms is negligible

Cross elasticity of demand is negligible Consumers have an unbound taste for variety and low

prices Firms maximise profits and entry is free

Every firm will produce a distinct variety rather than producing another firm's type and losing profits to competition

Analyzes the market solution in the monopolistic equilibrium addressing the question of quantity versus diversity

Widely used in several economic areas such as international economics, macroeconomics

Consumer Behavior: Utility Function◦ Every consumer shares the same tastes for the two type of goods

μ1μAMU M= composite index of the manufactured goods.A= consumption of the agricultural good.Mu (μ): constant expenditure share in manufactured

goods.

M is defined by a constant-elasticity-of-substitution (CES):– Rho (ρ): intensity of the preference for variety– If ρ=1, differentiated goods are nearly perfect substitutes– If ρ=0, the desire to consume a greater variety of goods increases

The Consumer’s Problem:

To maximize utility function subject to the budget constraint:

1. The consumption of varieties will be optimized:◦ The ideal consumption of each variety will be given by the

combination that ensures utility with the minimum cost (given the relative prices of each variety).

2. Once the consumption of varieties in generic terms has been optimized (for every M), the desired quantity of A and M will be chosen according to the relative prices of both goods.

where I is the income and pi is the price of commodity i

Case 1 : Pawnshops(United States)

Case 2 : Fast Food Industry(Taco Bell)

Problems:

1. In late 1991, there were about 8,000 pawnshops in the United States, according to American Business Information. This was much higher than in 1986, when the number was about 5,000. Indeed, in late 1991, the number jumped by about 1,000. Why did the number increase?

2. In a particular small city, do the pawnshops constitute a perfectly competitive industry? If not, what is the market structure of the industry?

3. Are there considerable barriers to enter in the pawnshop industry?

1. The pawnshop business appears to be highly profitable. We expect that entry to this market would follow huge profits unless there were barriers to the entry.

2. The market for pawnshop services is likely to be quite local, as local as perhaps neighbourhoods. In this case, even though there might be 100 pawnshops in a large city, the market for any individual shop is likely to be monopolistic.

3. Barriers to entry appear to be very low in this industry. Pawnshops do not appear to be any more difficult to start than restaurants or hardware stores.

Problems :

1. Consider the fast food industry, including companies such as Wendys, Burger King, Taco Bell, and so forth. Explain why fast food industry would be considered monopolistic competition?

2. The purpose of the advertising is to increase the demand for Taco Bell products and to make that demand more inelastic (that is, to have fewer real substitutes). Assume that the advertising succeeds in doing this. Show the new demand and marginal revenue on the graph for Taco Bell, assuming you begin in long-run equilibrium.

3. Explain what will result in the short-run to the quantity of Taco Bell products produced, the prices of them, and the economic profits of Taco Bell. Finally, explain what will result in the long-run?

Demand and Marginal Revenue Curve for Taco Bell

Some differentiation generates unnecessary waste, such as excess packaging.

Advertising may also be considered wasteful, though most is informative rather than persuasive.

There is allocative inefficiency in both the long and short run. This is because price is above least average cost in both cases. In the long run the firm is less allocatively inefficient, but it is still inefficient.

Thank You