Monopolistic competition basic things


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Monopolistic competition basic things

  1. 1. Monopolistic Competition Ayyappan 13-501-005
  2. 2. 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.
  3. 3. 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
  4. 4. 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
  5. 5. 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
  6. 6. Comparing perfect and monopolistic competition Perfect competition Monopolistic competition number of sellers many many free entry/exit yes yes long-run econ. profits zero zero Comparing Perfect & differentiated Monop. identical firm has market power? Competition yes none, price-taker the products firms sell D curve facing firm horizontal downwardsloping
  7. 7. Comparing Monopoly and Monopolistic competition Monopoly Monopolistic competition number of sellers one many free entry/exit no yes long-run econ. profits positive zero firm has market power? yes yes D curve facing firm downward-sloping downward(market demand) sloping close substitutes none many
  8. 8. 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.
  9. 9. 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
  10. 10. 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.
  11. 11. 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.
  12. 12. 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.
  13. 13. 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.
  14. 14. 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.
  15. 15. Long run zero profit Point of tangency Quantity
  16. 16. (a) Effects of Entry (b) Effects of Exit Entry shifts the existing firm’s demand curve and its marginal revenue curve leftward. MR 2 MR 1 D 2 D 1 Quantity Exit shifts the existing firm’s demand curve and its marginal revenue curve rightward. MR 1 MR D1 2 D 2 Quantity
  17. 17. 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.