Download Monopolistic Competition: A Microeconomic Analysis and more Schemes and Mind Maps Microeconomics in PDF only on Docsity!
Objectives:
- Enumerate the characteristic of a monopolistic competition.
- Recognize how short-run profit maximizing prices and outputs are achieved by a monopolistic competitive firm.
- Illustrate how short-run loss minimizing prices and outputs are determined by a monopolistic competitive firm.
- Explain how long-run profit maximizing prices and outputs are achieved in a monopolistic competitive market when entry of new firms to the market is blocked and when entry is open.
- Give examples of monopolistic firms in the country at present.
- List the merits and shortfalls of the monopolistic competitive market.
CHAPTER 9: MONOPOLISTIC COMPETITION
INTRODCUTION
Imperfect Competition We have discussed pure competition and monopoly in Chapter 8. In a purely competitive industry, many firms are present; in contrast, only one firm is involved in a pure monopoly. For many years, economists felt that these two models were adequate to analyze any market. This situation lasted until the late 20’s. As we know, between the extremes of pure competition and monopoly, there exists “intermediate” market structures that can be classified into two categories:
- monopolistic competition; and
- oligopoly These two market structures are often lumped together in a market characterized by “imperfect competition”.
One of the most notable achievements of economists who examined the middle ground between pure competition and monopoly was the American economist, Edward H. Chamberlin, Who developed the theory of monopolistic competition. E. H. Chamberlin based his theory of monopolistic competition on solid empirical fact: there are only very few honest-to-goodness monopolies because there are very few commodities; for which close substitutes do not exist; similarly, there are very few commodities that are entirely homogeneous. Instead, there is a wide range of commodities; some of which have relatively few good substitutes and some of which have many good but not perfect substitutes. In many cases, products are heterogeneous rather than homogeneous; thus, pure competition cannot exist because of its assumption of homogeneity. On the other hand, although heterogeneous, the products are only slightly different. Competition exists because each is a close substitute for the other.
PRODUCT DIFFERENTIATION
The basic idea behind monopolistic competition is that most firms face relatively close substitutes and that most commodities are not completely homogeneous from one producer to another. This concept is what we call product differentiation. Firms in a purely competitive market produce a standardized product while monopolistically competitive producers turn out variations of a given product. A number of firms produce toothpaste, for example. However, the product of each firm differs from its rival in various ways. When a consumer wants to buy toothpaste, he specifies the brand of the toothpaste he wants. He does not go to the store and orders toothpaste; he goes to the store and orders “Colgate” or “Close-Up” or whatever brand he wants. Because of product differentiation, the producers spend significant amounts for advertising and promotion to increase sales. In a market characterized by monopolistic competition, competition centres not only on price but also on product quality, advertising and sales promotion.
Short-run Loss Minimization It is possible that because of unhealthy and cutthroat competition, a less favorable cost and demand situation may exist, putting the monopolistically competitive firms in the position of incurring losses in the short run. When we talk about long-run equilibrium, we refer to the three types of adjustments firms are faced with: (1) the firm can build any desired size of plant; (2) where entry is open and when profits are being made, it is possible for new firms to enter the market; and (3) in case losses are being incurred, losing firms can make an exit in the industry. Adjustment: Entry Blocked Blocked entry into an industry characterized by monopolistic competition will not be the usual case; still it may, and sometimes does occur. When it occurs, it is usually the result of legislative activity of some kind. Owners or operators of the firms in a particular industry may belong to a trade association that has political influence on a local, foreign, or perhaps even a nationwide basis. The industry may be fairly profitable, and the trade association may foresee the possibility of wholesale entry into the industry. Therefore, it may use its influence to secure the enactment of legislation that is rationalized as insuring an adequate supply on the commodity at prices allowing those in the trade to make fair and reasonable profits. In the service trades in a particular city or state, one can easily find licensing laws that tend to block entry.
MONOPOLISTIC COMPETITION, MONOPOLY, AND PURE COMPETITION: A
COMPARISON
We have already discussed the characteristics of monopolistic and pure competition. From these discussions, we can make several comparisons. Among these are the following: First, the firm under monopolistic competition is likely to produce fewer goods and charge relatively higher prices than under pure competition. There is comparatively less number of producers existing under monopolistic competition. This would account for fewer goods produced as compared with a market characterized by pure competition. In addition, less number of firms under monopolistic competition would enable producers to charge relatively higher prices than under pure competition. The demand curve facing the monopolistic competitor is not perfectly elastic, as it is in pure competition. Since marginal revenue is less than the price in monopolistic competition, the firm will produce less than the amount at which price equals marginal cost, resulting to less production than under pure competition. Second, in comparison with monopoly, firms under monopolistic competition are likely to have greater output, lower prices, and thus lower profits. The firms in a product group might obtain pure profits if they were to collude, i.e., if entry into the industry is blocked. Producers would prefer a market characterized by pure monopoly because profits are greater compared with those
prevailing under monopolistic competition. From the point of view of the consumers, however, they would be worse off because of higher prices and output restriction. Third, firms under monopolistic competition may be somewhat inefficient, because they tend to operate with excess capacity. This inefficiency is seldom found under pure competition, which could mean the exit of a firm from the industry. Inefficiencies may not be very great in the monopolistically competitive firm because the demand curve is likely to be high elastic. Thus, we can say that the more elastic the demand curve, the less excess capacity the firm tend to have.
WELFARE EFFECTS OF MONOPOLISTIC COMPETITION
Output Restriction If one of the industries of a purely competitive economy in long-run equilibrium were to become monopolistically competitive, welfare would tend to be reduced by a sight restriction of output and a slight increase in the prices charged for the product. In other words, since prices are relatively higher under a monopolistically competitive firm consumers would receive less welfare than under a purely competitive economy. The demand curve faced by the monopolistic competitor, though very elastic, is less than perfectly elastic. Marginal revenue for the individual firm is less than the price, and the rate of output is stopped short at which marginal cost equals the product price. Thus, comparatively less output is expected under a monopolistic competition than under pure competition. In the long-run, price will equal the average cost of production unless entry into the industry is blocked. When entry is free and easy-as it appears to be the usual case-new firms enter the profit production of the product. The organization of the economy’s productive capacity can follow consumer’s tastes and preferences with a high degree of accuracy. When entry into profit-making industries is blocked, the consequences with respect to price and average costs are much the same as they are under pure monopoly. The productive capacity of the economy cannot be organized to conform accurately to consumer’s tastes and preferences. Additional quantities to resource are prohibited from moving into the profit-making industries where they would be more productive than they are in alternative employments. Efficiency of Individual Firms A most efficient size of plant would involve the firm in losses since average cost at such an output would be greater than price. If the long-run average cost curve lies below the demand curve for any range of outputs, pure profits can be made by any firm that builds the correct size of plant for any one of those outputs. New firms will enter until profits are eliminated. Profits are eliminated when individual firms long-run average cost curves are tangent to the demand curves faced by them. Losses are incurred when the long-run average cost curve lies above the demand curve for all outputs. Exit of firms from the industry will continue until the long-run average cost curve for each firm again touches the demand curve faced by it.
For more knowledge, please follow the link provided; https://www.youtube.com/watch?v=T3F1Vt3IyNc https://www.youtube.com/watch?v=jjKjUAiVVu
https://www.youtube.com/watch?v=8a3gXThQeK
