MONOPOLISTIC COMPETITION

BY ELIF YURTSEVER

1B

CHARACTERISTICS

• 1) A relatively large number of sellers

• 2) differentiated products (often promoted by heavy advertising)

• 3) easy entry and exit from the industry

1) large number of sellers

• Smaller market shares- each firm has a small percentage of the total market and limited control over market price.

• No collusion- large number of firms ensure that collusion by a group of firms to restrict output and set prices is unlikely.

• Independent action- numerous firms, each firm can determine their own prices without worrying about rival firms. A single firm might see a increase of sale by cutting prices, but will cause no effect from competition.

2) Distinguished by product differentiation. Monopolists produce products with slightly different variations

• Product Attributes- functional features, materials, design• Ex: Personal Computers differ in storage capacity, speed, color, graphic display

• Service and the conditions surrounding the sale• Ex: Customers prefer 1-day rather than 3-day dry cleaning with the same quality

• Location and accessibility of the stores• Ex: hotel close to an interstate highway gives it a locational advantage and may charge higher

• Brand names and packaging and celebrity connections• Ex: Nike rather than Puma

• Some control over price • Monopolistic control over price is limited due to lots of substitutes for the product

• Advertising• Nonprice competition is to make price less of a factor in consumer purchases and make product differences

a greater factor

3) easy entry and exit from the industry

• Economies of scale are few and capital requirements are low because competitors are small firms

• Compared to pure competition, financial barriers may result from advertising

• Some companies have patents or copyrights on their brand names making copying the product difficult

• There is nothing to prevent n unprofitable monopolistic competitor to go out of business

DEMAND CURVE

• The basic feature of the diagram is the elasticity of demand. The demand curve faced by a monopolistically competitive seller is highly elastic, but not perfectly. This is what distinguishes monopolistic competition vs. pure competition.

• The demand is more elastic because monopolistically competitive seller has many competitors producing closely substitutable goods.

• Reasons why demand is not perfectly elastic• 1) fewer rivals

• 2) Products are differentiated, so not perfect substitutes

• Price elasticity is based on number of rivals and degree of product differentiation.• Larger the number, weaker the differentiation

• Greater the price elasticity, closer to monopolistic competition will be to pure competition

GRAPHICAL REPRESENTATION

In the long run, easy entry and exit of firms cause monopolistic competitors to earn only a normal profit/ they will break even

In the short run, a monopolistic competitor will max profit or min loss by producing that output at which marginal revenue equals marginal cost

• Profits: Enter• As new firms enter, the demand curve shifts to the left because each firm has a smaller share

of total demand and faces a larger number of close-substitute products. This reduces the economic profit.

• When entry of new firms reduce demand to the extent that the demand curve is tangent to the ATV at the profit-max output, the firm makes normal profit.

• Losses: Leave• When faced with fewer substitutes and an expanded share of total demand, surviving firms

will see their demand curve shift to the right. Losses will disappear and give way to normal profits.

• Complications • Monopolistic competition earns only a normal profit in the long run. However, that outcome

may not always occur.

EFFICIENCY OF MONOPOLISTIC COMPETITION• Economic efficiency requires P=MC= minimum ATC. This yields

productive efficiency. The good is being produced in the least costly way and the price is just sufficient to cover ATC, including normal profit.

• P=MC yields allocative efficiency. The right amount of output is produced, so the right amount of society’s scare resources is being devoted to this specific use.

• Monopolistic competition is neither productive nor allocative in the long run. As seen, profit-max slightly exceeds the lowest ATC, therefore producing the profit-max, ATC is slightly higher than optimal from society’s perspective/ productive efficiency is not achieved.

• Allocative efficiency is not achieved since the product price exceeds the MC and results in an underallocation of resources and excess productive capacity of Q4-Q3

• Excess capacity- plant and equipment that are underused because firms are producing less than minimum ATC output. Thus, competitive industries are crowded with firms, each operating below optimal capacity.

PRODUCT VARIETY

• Since consumers have a wide diversity in tastes (ex: some like curly fries vs. regular fries) then at any time, the consumer will be offered a wide range of types, styles, brands, and quality of that product.

• When compared to pure competition, this provides an advantage to the consumer

• Society benefits from better products when monopolistic competition differentiates products and expands choices since a successful product obligates rivals to improve on that firm’s temporary market advantage or else lose business.

• Product attributes and advertising are not fixed, there are three factors- price, product, and advertising- when seeking maximum profit. This complex situation is not easily expressed. At best, we can say that each possible combination of price, product, and advertising shows a different demand and cost situation, and one yields the max profit. One must use trial and error to fin the optimal combination.