ECONOMICS FOR MANAGERS

PSG INSTITUTE OF MANAGEMENT MBA 2011-13 BATCH I Trimester

Session XIII- For Batch C and D Markets and Competition- Monopolistic Competition
1 EFM faculty P.Uday Shankar 26/09/11

What is Monopolistic Competition ?

Pure monopoly and perfect competition are two extreme cases of market structure. In reality, there are markets having large number of producers competing with each other in order to sell their product in the market. Thus, there is monopoly on one hand and perfect competition on other hand. Such a mixture of monopoly and perfect competition is called as monopolistic competition. It is a case of imperfect competition. The credit of introducing Monopolistic Competition goes to American Economist Prof. Edward Chamberlin, who had described it in his book 'Theory of Monopolistic Competition' published in 1933.
2 EFM faculty P.Uday Shankar 26/09/11

What is Monopolistic Competition?

As the name monopolistic competition suggests, the industry shares characteristics of both a perfectly competitive industry and a monopoly. Like perfect competition, a monopolistic competitive industry has many firms, or if there are not many firms, there are at least many competing products that are almost identical in nature. Consider the Laptop industry. There are several major producers of Laptops (e.g. Toshiba, HP, DELL, ACER, HCL) and each produces a laptop and many other variations that can fit the consumers desire. In addition, there are a good number of smaller specialty brands that produce laptops such as Apple. EFM faculty P.Uday Shankar 26/09/11

Monopolistic Competition- Characteristics

No.of sellers: There are large number of sellers producing differentiated products. So, competition among them is very keen. Since number of sellers is large, each seller produces a very small part of market supply. So no seller is in a position to control price of product. Every firm is limited in its size. 2. No.of buyers: They are also large in number and have a the choice of a variety of substitutes of a product. 3. Product Differentiation: It is one of the most important features of monopolistic competition. In perfect competition, products are homogeneous in nature. On the contrary, here, every producer tries to keep his product dissimilar than his rival's product in order to maintain his separate identity. This boosts up the competition in market. So, every firm acquires some monopoly power. EFM faculty P.Uday Shankar 26/09/11
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Monopolistic Competition- Characteristics

4. Freedom of Entry and Exit: There are minimal barriers

to entry of sellers. The goods and services produced are easy to replicate by other firms that represent potential competition. If economic profits are present, new firms will enter into the industry. Entry of new firms happens mostly in the long run. 5. Selling Cost: It is a unique feature of monopolistic competition. In such type of market, due to product differentiation, every firm has to incur some additional expenditure in the form of selling cost. This cost includes sales promotion expenses, advertisement expenses, salaries of marketing staff, etc. But on account of homogeneous product in perfect competition and zero competition in monopoly, selling cost does not exist there. 6. Interdependence among sellers: Large numbers of firms
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are different in their size. Each firm has its own production and marketing policy. So no firm is influenced by other firm. EFM faculty P.Uday Shankar 26/09/11 All are independent.

Monopolistic Competition- Characteristics

7. Demand Curve: In monopolistic competition, a firm is facing downward sloping demand curve i.e. elastic demand curve. It means one can sell more at lower price and vice versa. 8. Behaviour in a Short Run: Firms in monopolistic competition can behave like monopolies in the short run by having considerable market power to generate profit. 9. Behaviour in the Long Run: In the long run new firms enter the market and the benefits of differentiation (which existed during the short run) decrease with the competition. The market then behaves more like in the perfect competition where firms cannot gain economic profit. 10. Behaviour of the Consumer: If consumers lack rationality and innovativeness in choosing the products and if heuristics is required to determine consumer choice the market will fall under natural monopoly (in the absence of government regulation/control).
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Monopolistic Competition- Characteristics

11. Competition: There exists a two dimensional

competition. 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.

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Monopolistic Competition- Short Run Profits

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Monopolistic Competition- Short Run Profits

The above figure shows the short run behavior of the monopolistically competitive firm. As in the case of a perfectly competitive firm or a monopoly, the monopolistically competitive firm produces at a profit maximizing level of output where marginal cost equals marginal revenue (Point A). The firm finds the price it will charge customers at the profit maximizing level of output (Q*) from the demand curve at Point B, and sets price to P*. As we can see from the shaded region, the firm is earning economic profits since price exceeds average total cost at the profit maximizing level of output.
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Monopolistic Competition- Short Run Profit and Loss

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Monopolistic Competition- Long Run

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Monopolistic Competition- Long Run

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Unlike a monopoly industry, new firms can enter the monopolistically competitive industry. And like a perfectly competitive industry, economic profits attract new firms seeking a share of those profits into the industry. The long run outcome for the monopolistically competitive firm is zero economic profits. This is shown in the figure above. Demand shrinks from D0 to D1 eventually settling at a point where the demand curve is tangent to the average total cost curve, resulting in zero economic profits (Point B). Note that the marginal revenue and marginal cost curves are excluded from the figure to EFM faculty P.Uday presentation clearer. make the Shankar 26/09/11

Monopolistic Competition- Long Run

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As we can see from the figure above, unlike a perfectly competitive firm that produces at the minimum point of its average total cost curve and where price equals marginal cost, the monopolistically competitive firm does not produce at an economically efficient point in the long run. This does not mean to say that monopolistic competition is undesirable in comparison to perfect competition. Consumers value choice, and monopolistic competition offers variety in good or service. In contrast, perfectly competitive firms produce a generic, homogenous product offers consumers no EFM faculty differences. 26/09/11 productP.Uday Shankar

Monopolistic Competition- Long Run

Monopolistic competition also encourages continuous product innovation. Innovative firms that introduce new or better products gain an edge, increase market share and can realize extra profits while their competitors attempt to catch up. A key to success for many firms in monopolistically competitive industries, especially in the information technology area, is constant innovation to maintain and expand market share.

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Thanks

http://spot.colorado.edu Thanks for the graphs and material.

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