Monopolistic competition

MONOPOLISTIC COMPETITION

Prof. Prabha Panth,Osmania University,

Hyderabad

01/05/2023 Prabha Panth

Monopolistic Competition• Capitalist markets are neither pure monopoly nor

perfect competition.• Monopolist cannot fully stop competition, because

some rival firms will enter.• And perfect competition does not really exist, there

will always be some monopoly factors in it.• Therefore capitalist markets could have some features

of monopoly and some of perfect competition.• Joan Robinson and Edward Chamberlin called such a

market as “Monopolistic Competition.”2


Characteristics

Monopolistic competition refers to a market organisation that has many sellers of a differentiated product.

Characteristics:1. Large number of buyers and sellers, but

less than in PC. 2. Sellers cannot influence each other in the market3. Differentiated products: heterogeneous – so each

seller is a monopolist for his brand. Price maker.

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4. D-curve for each firm is downward sloping, high price elasticity as there are many substitutes.

5. U-shaped cost curves.6. Free entry and exit.7. High cross elasticity: Many substitutes, so if firm A’s price

increases, consumers shift to B.8. No industry, but a group of firms producing similar but

differentiated products.9. Advertisement costs are extra costs in this market.10. Firms do not anticipate or retaliate to other firms’ market

practices. Are independent of each other.11. Non-price competition

Characteristics

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Product Differentiation • Non homogeneous and differentiated products.• Real or perceived differences of products, but

same in actual purpose of use.• Differences could be due to:– External features, such as branding of commodity

or features such as packaging– Internal features such as colour, perfume, shape,

size, – Examples: soaps, tooth paste, cosmetics, shampoos,

ready made, textiles, confectionery

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Short Run Equilibrium of a MC firm

• The firm is rational – wants to maximise its profits.• Faces a downward sloping D-curve for its product.• Price maker.• AC includes Selling Costs. Has to advertise to

attract consumers.• Chamberlin’s two heroic assumptions:

1. Symmetry in Demand: all firms have the same demand levels. All firms are of the same size.

2. Uniform costs: all firms have the same levels of cost – U-shaped cost curves

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Short Run Equilibrium

RC

0 Q

D = AR

MR

SAC

SMC

F

Q1

E P

C C1

ABNORMAL PROFITS

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Firms earn short run profits by using the conditions for profit maximisation: - 1) MC = MR2) MC rising


Product Differentiation and Advertisement

• Short term profits earned through successful advertisements.

• Advertisement needed to show product differentiation and attract consumers.

• But in the long run, other firms also advertise, or bring in other innovations.

• Mono-comp firms tend to cluster together, to attract customers from each other, called the “spill over effect”:– E.g. restaurants, medical shops, mechanics, gold and

jewellery shops8


Long Run Equilibrium

• In the long run the Mono-Comp firm faces three situations: With free entry, the market size of each firm

decreases, Selling costs increase, and Economies of scale

• In the long run, the MC firm will earn only normal profits.

• But at an output < PC, and with excess capacity.• Inefficiency in production.

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Long Run Equilibrium

RC

0 Q

D = AR

MR

LACLMC

F

E P = AC

Q1

Normal Profit

Efficient level of Production

G

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Long run equilibrium

• Demand curve is less steep, and market share of firms decrease due to entry of new firms.

• Demand curve of a firm will shift downwards due to entry of new firms,

• Given the long run costs, equilibrium output, OQ1 gives zero profit, for at E, LAC = AR.

• But minimum LAC is at G, the level of efficient production.• The firm stops production at E, which is the falling part of

the LAC curve• Hence the firm, though getting zero profit in the long run,

is not as efficient as a firm in perfect competition.


PC Mon-Comp MonopolyNumber of firms Large nos Large nos < PC Single firm

Demand curve Horizontal straight line

Downward sloping (gentle)

Downward sloping (steep)

Elasticity - Infinity Elastic (- e > 1) Inelastic (- e < 1)

Price Price taker Price maker Price maker

Product Homogeneous Differentiated No substitutes

Entry Easy Easy BlockedShort run profits Possible yes yesLong run profits Normal profits Normal profits Abnormal profitsEfficiency and size Optimum Efficient

(minimum LRAC)Inefficient, > optimum (LRAC)

Inefficient, > optimum (LRAC)

Capacity use Full Capacity Excess capacity Excess capacity

Welfare to consumers

P = MC P > MC P > MC


Selling Costs

• Selling costs include • Promotion expenses, • Packaging, and • Advertisement expenditure.• Free gifts,

• Through this the firms want to influence consumers’ demand.

• But it also leads to increase in their costs.• These costs are extra in Mono-comp as compared to

other markets.13


Merits of Advertising

• Mono-comp firms show product differentiation through advertising.

• Merits of Advertisement: Information on new products, and

improvements in old products, Consumers made aware of better deals and

offers. Reduces asymmetric information between seller

and the consumer. Intensifies competition, innovation and efficiency

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Demerits

• Manipulates consumer tastes, without conveying any useful information. (e.g. fashions, food and drink habits, new gadgets)

• Advertising may also try to create differentiation within products that are actually very similar.

• Advertising tries to make demand curves less elastic, and impedes competition.

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Demerits of Advertisement

• Product differentiation encourages brand loyalty, and makes consumers less price sensitive

• This then leads to a high mark up over marginal cost.

• Increases the ability of firms to charge more than marginal cost. Market power.

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Demerits of Advertisement

• Heavy spending on advertising creates barrier to entry, as new firms also have to spend on advertising.

• Wasteful costs on advertisement.• Affects size and quality of the product.• Wrong and misleading information, harmful

effects not shown. (smoking, junk food, colas)• Unethical and dangerous ads.

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Questions

Short Answers:1. What is meant by differentiated products? Why

is this necessary in Monopolistic Competitive?2. What are the extra costs of production borne by

a firm in monopolistic competition?3. How does a monopolistic competitive firm

achieve short run equilibrium?

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Essay Questions:1. Compare Monopolistic competition to a) monopoly,

and b) perfect competition?2. Explain the long run equilibrium situation of a

monopolistic competitive firm. How does it differ from other markets?

3. What are selling costs? What are the advantages and disadvantages – to the firm and to the consumers?

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Education

Monopolistic competition