Monopolistic Competition

What is Market?
Market is public place or a region where buyers and sellers enter into transaction directly or through intermediates.

There are two types of market Perfect Competition Imperfect Competition

Monopolistic Competition is a type of imperfect competition.

What is Monopolistic Competition?

Monopolistic Competition is a market structure in which there are several or many producers; in which each produces similar but slightly differentiated products. Differentiation can be on the basis of colour, design, size, taste, fragrances, quality etc. Each producer can set its price and quantity without affecting the marketplace as a whole.

Or:Monopolistic competition is a form of imperfect competition where many competing producers sell products that are differentiated from one another (that is, the products are substitutes, but, with differences such as branding, are not exactly alike).

Fact:The "founding father" of the theory of monopolistic competition was Edward Hastings Chamberlin in his pioneering book on the subject Theory of Monopolistic Competition (1933). Joan Robinson also receives credit as an early pioneer on the concept.

Introduction to the Concept

Monopolistic Competition differs from perfect competition. In that production does not take place at the lowest possible cost. Because of this, the firms are left with excess production capacity. y In monopolistic competition firms can behave like monopolies in the short-run, including using market power to generate profit. y In the long-run, other firms enter the market and the benefits of differentiation decrease with competition; the market becomes more like perfect competition where firms cannot gain economic profit. y Textbook examples of industries with market structures similar to monopolistic competition include restaurants, cereal, clothing, shoes, and service industries in large cities.
y

Characteristics of Monopolistic Competition:Competition:1.Product Differentiation- Monopolistic Competitive firms sells products that have real or perceived non-price differences. But the differences are not that huge so as to eliminate the products as substitutes. They are best described as close but imperfect substitutes, which perform the same functions but differ in quality, reputation, appearance, style etc.

2.Many Firms- There are many firms in each monopolistic competitive product group and many remain on the sidelines all set to enter the market. A product group is called a collection of similar products. Due to the existence of many firms each monopolistic competitive firm has the freedom to set the price without much of strategic thinking as the increase/decrease in price has a negligible impact on the market.

3.Free entry and exit- In the long run the firms awaiting to enter the monopolistic competitive market with its own unique product or in search of positive profit and the ones unable to cover its costs can join and leave the market on their own will without incurring liquidation costs.

Cont

Characteristics of Monopolistic Competition:Competition:4.Independent decision making- Each monopolistic competitive firm independently sets the term of exchange for its product, without giving any consideration to the effect of their decision on their competitors .The theory is that any action will have such a negligible effect on the overall market demand that an Monopolistic Competitive firm can act without fear of prompting heightened competition. 5.Market Power- Monopolistic competitive firms have some degree of market power, i.e. the firm will have control over the terms and conditions of exchange. They can raise their price without losing their customers and they can lower the price without triggering a war with the competitive firms. They derive their market power from the fact that they have relatively few competitors who do not enter in strategic decision making and the firms sell differentiated products. Market power also means negative demand curve.

6.Perfect Information- Buyers know exactly what goods are being offered, where the goods are being sold, the different characteristics of the goods, the price of the goods, and if or how much profit a firm is making.

Cont

In Short Run:Run:The firm maximizes its profits and produces a quantity where the firms marginal revenue(MR) is equal to its marginal cost (MC). The firm is able to collect a price based on the average revenue curve. The difference between the firms average revenue (AR) and average cost (AC) gives it a profit.

1.Marginal Revenue is always less than demand. 2.Profit is maximized where MR=MC 3.profit=(price-average total cost) x quantity

In Long Run
The firm still produces where marginal cost and marginal revenue are equal. A firm making profits in the short run will break in the long run because demand will decrease and so there s a shift in demand curve and Average revenue as the other firms enter the market and increase competition. The firm no longer sells its goods above average cost and can no longer claim an economic profit.

Inefficiency in Monopolistic Competition:Competition:There are two sources of inefficiency :1.

2.

At its optimum output the firm charges a price that exceeds marginal costs, the Monopolistic Competitive firm maximizes profits where MR = MC. Since the MC firm's demand curve is downward sloping this means that the firm will be charging a price that exceeds marginal costs. The monopoly power possessed by a MC firm means that at its profit maximizing level of production there will be a net loss of consumer (and producer) surplus. The fact that Monopolistic Competitive firms operate with excess capacity. That is, the Monopolistic Competitive firm's profit maximizing output is less than the output associated with minimum average cost. Both a Perfect Competition and Monopolistic Competition firm will operate at a point where demand or price equals average cost. For a Perfect Competitive firm this equilibrium condition occurs where the perfectly elastic demand curve equals minimum average cost. A Monopolistic Competitive firm s demand curve is not flat but is downward sloping. Thus in the long run the demand curve will be tangent to the long run average cost curve at a point to the left of its minimum. The result is excess capacity.

Conclusion
Monopolistic Competition has been rightly explained as:-A market situation midway between the extremes of perfect competition and monopoly, and showing features of both. In such situations firms are free to enter a highly competitive market where several competitors offer products that are close (but not perfect) substitutes and therefore prices are at the level of average costs ( feature of perfect competition). Also, some consumers have a preference of one product over another that is strong enough to make them keep buying it even when its price increases, thus giving its producer a small amount of market power (a feature of monopoly).

Reference:Reference:www.wikipedia.org y www.123oye.com y www.basiceconomics.info y www.ingrimayne.com

y

Microeconomics by S.Chand