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Monopolistic CompetitionAyyappan13-501-005
Definition and history
The model of monopolistic competition describes a common
market structure in which firms have many competitors, but each one sells
a slightly different product.
Monopolistic competition as a market structure was first identified in the
1930s by American economist Edward Chamberlin, and English economist
Joan Robinson
In the case of restaurants, each one offers something different and
possesses an element of uniqueness, but all are essentially competing for
the same customers.
Characteristics
• Many sellers and buyers
• Product differentiation
• Free entry and exit
• In Short Run
• In Long Run
• Advertisement and propaganda is a major feature
• Brand names
Many sellers and buyers
• The number of firms in monopolistic competition is fairly large. Each firm
produces or sells a close substitute for the product of other firms in the
product group or industry. Product differentiation is thus the hallmark of
monopolistic competition.
Product differentiation
• The firms sell differentiated products. Product differentiation may be real
or imaginary. Real differentiation is done through differences in the
materials used, design, colour etc. Imaginary differences may be created
through advertisement, brand name, trade marks etc
There are three important forms of product differentiation:
Differentiation by style or type
Differentiation by location – dry cleaner near home vs. cheaper dry cleaner
far away
Differentiation by quality – ordinary vs. gourmet chocolate or branded
Comparing perfect and monopolistic competition
Comparing Perfect & Monop. Competition yesnone, price-takerfirm has market power?
downward-sloping
horizontalD curve facing firm
differentiatedidenticalthe products firms sell
zerozerolong-run econ. profits
yesyesfree entry/exit
manymanynumber of sellers
Monopolistic competition
Perfect competition
Comparing Monopoly and Monopolistic competition
yesyesfirm has market power?
downward-sloping
downward-sloping
(market demand)D curve facing firm
manynoneclose substitutes
zeropositivelong-run econ. profits
yesnofree entry/exit
manyonenumber of sellers
Monopolistic competition
Monopoly
Aspects
Monopolistic competition has two types of competition aspects viz.
• Price competition i.e. firms compete with each other on the basis of price.
• Non price competition i.e. firms compete on the basis of brand, product
quality advertisement.
Price determination
• Under monopolistic condition different firms produces different varieties
of product ,there for different prices for their own productwill be
determined in the market depending up on their respective demand and
cost condition.
• under monopolistic competition the producer must take optimal
adjustment not only in the price charged and as regard as quantity of output
sold but also in the design of the product and the way in which he
promotes the sales
The Firm’s Short-Run Output and Price Decision
A firm that has decided the quality of its product and its
marketing program produces the profit-maximizing
quantity at which its marginal revenue equals its marginal
cost (MR = MC).
Price is set at the highest price the firm can charge for the
profit-maximizing quantity.
The price is determined from the demand curve for the
firm’s product.
• .
Price and Output in Monopolistic Competition
– The firm produces the quantity at which marginal revenue equals marginal cost
– and sells that quantity for the highest possible price.
– It makes an economic profit (as in this example) when P > ATC.
Price and Output in Monopolistic Competition
• Profit Maximizing Might be Loss Minimizing– A firm might incur
an economic loss in the short run.
– Here is an example.– In this case, P <
ATC.
Long Run: Zero Economic Profit In the long run, economic profit induces entry.
And entry continues as long as firms in the industry make an economic profit—as
long as (P > ATC).
In the long run, a firm in monopolistic competition maximizes its profit by producing
the quantity at which its marginal revenue equals its marginal cost, MR = MC.
As firms enter the industry, each existing firm loses some of its market share.
The demand for its product decreases and the demand curve for its product shifts
leftward.
The decrease in demand decreases the quantity at which MR = MC and lowers
the maximum price that the firm can charge to sell this quantity.
Price and quantity fall with firm entry until P = ATC and firms earn zero
economic profit.
Long run zero profit
• In the long run, equilibrium of a monopolistically competitive
industry, the zero-profit-equilibrium, firms just break even.
The typical firm’s demand curve is just tangent to its average
total cost curve at its profit-maximizing output.
Long run zero profit
MRMC
DMC
MC
ATC
Z
QMC
MC= ATC
MC
Point of tangency
Price, cost, marginal revenue
Quantity
Entry and Exit Shift Existing Firm’s Demand Curve and Marginal Revenue Curve
(a) Effects of Entry (b) Effects of Exit
Exit shifts the existing firm’s demand curve and its marginal revenue curve rightward.
MR2
MR2
MR1
MR1
D1 D
1D2
D2
Entry shifts the existing firm’s demand curve and its marginal revenue curve leftward.
Price, margina
l revenue
Price, margina
l revenue
Quantity Quantity
The Role of Advertising
In industries with product differentiation, firms advertise in order to
increase the demand for their products.
Advertising is not a waste of resources when it gives consumers useful
information about products.
Either consumers are irrational, or expensive advertising communicates
that the firm's products are of high quality.
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