Me M7 Monopolisitc CompetitionPresentation Transcript
MONOPOLISTIC COMPETITION ME - M-7
WHAT IS MONOPOLISTIC COMPETITION
Monopolistic competition refers to competition among a large number of sellers of similar but differentiated products which means that the products sold by different firms are close, but not perfect, substitutes for one another.
The number of buyers and sellers in the ‘group’ is sufficiently large.
The goods offered by different producers though different are close substitutes.
There is freedom of entry (freedom to produce substitutes) and exit of firms in the ‘group’.
The sole object of the firm is to maximize profits both in the short-run and in the long run.
The firm operates with the belief that it definitely possesses information regarding the demand curve of its product and the cost curve.
The long-run is constituted of several short periods which are free from one another.
Q . Product differentiation is the basic condition giving rise to monopolistic competition. Explain. Under monopolistic competition, sellers are numerous but no one of them is in a position to control a major part of the supply of the common commodity, which all of them are offering for sale. But each seller so differentiates his portion of the supply of that commodity From the portions sold by others that buyers hesitate to shift their purchases to other in response to price differences. Products like toothpastes, soaps, cigarettes, scooters, photo-copiers, computers, etc. are subject to a large degree of product differentiation. So long as a consumer has an impression that the product brand is different and superior to others, he will be willing to pay more for that brand than for any other brand of the same commodity.
Product Differentiation (Contd.)
The differences, real or illusory, may be built up in the mind by
Recommendation of friends,
publicity campaigns and claims made by advertisers,
his own experience and observation.
The producer gains and retains his customers by,
competitive advertising and sales promotion
the use of brand names and by
Product Differentiation (Contd.)
A firm in monopolistic competition has three options open to it to promote sales:-
It can change its price and indulge in price competition
It can intensify the differentiation of its product, and
Increase its advertisement and sales promotion efforts.
Loss Leader Pricing
Retailers often price certain items at very low levels to attract large numbers of extra customers to their stores/shops thereby expanding their sales of higher prices items and adding to their total profits.
The items sold at lower prices are known as loss leaders.
1.A large number of customers are able to try out various items at throw away prices. If the product turns out to be good and acceptable to the customer, he may come back to buy it even at regular prices, thus increasing the demand for the product.
2.On the other hand, it helps the draw more number of customers, who get an opportunity to check, inspect various other products of the company, and make their purchase decisions. The producer is thus able to mop up the surplus money available with the customer.
‘Mark Up’ and ‘Mark Down’
When the retailer fixes the price such that it covers costs and leaves a reasonable profit margin , he is said to follow a ‘mark up’ policy.
In case certain goods are not sold within a reasonable time, the goods are ‘marked down’, that is the price is reduced, by a percentage which will not generally put the retailer to a loss.
Economic theory suggests that a firm should set its price MR = MC. In practice it is not possible to determine the price in this manner. Firms, therefore adopt a simple method by adding a ‘marking up’ over costs. Markups differ from product to product, firm to firm and industry to industry.
Mark up can be calculated as a percentage increase over average cost or simple as a difference between the price and average cost.
For a Monopolist, the profit maximising price is obtained by
Price = MR. e/e- 1 i.e. MC .e/e- 1
since MR=MC is the profit maximising output (equilibrium condition) under monopoly.
e= elasticity of demand , e-1 is the mark-up factor.
Based on several studies, it is established that this formula gives more or less the oprimum price mark-up possible.
For example, if elasticity e = 1.2, e-1 will be 0.2 and the mark-up will be 6 times the marginal cost.
If the elasticity is 2, e-1 will be 1, and the max. mark up is double the marginal cost.
“ Mark-up” method is a common method used in all non-competitive markets.
A bilateral monopoly is a market where one producer has an output monopoly and there is only one buyer for the product.
One sole seller and one sole buyer.
Under bilateral monopoly, the monopoly firm will fail to obtain a price above equilibrium, because the single buyer has the capacity to influence the price by his purchasing decisions.
Retailers often resort to this sort of pricing. They assign special roles to various products they sell. Some items may be used as promotional items which are priced and advertised with the prime purpose of attracting customers into the store; others may be intended to make up for the low margin obtained on promotional items.
Dual pricing is a price control device and refers to a two-price system. Fixed price is applied to a part of the output. Remaining output is sold at prices determined by market forces.
Fixed price may be determined to cover the cost of production and a reasonable profit margin. But this price will be much lower than the price that can be obtained in the open market.
e.g. in the case of sugar, the price for is fixed by govt. for a portion of the production of sugar factories (say 50%) and the rest of the production is allowed to be sold at free market prices.
This policy is to protect the vulnerable section of the population.
These are prices fixed by Government and is mostly based on political considerations.
An example is the pricing of petroleum products. Whenever the crude prices go beyond $60 per barrel the Petroleum marketing companies suffer a loss. This loss is made good by issuing them petro-bonds.
When the price of crude goes below this level, the petroleum marketing companies stand to gain. Ultimately there will be pressure to bring down the administered price.
Transfer price is the price applied to goods and services transferred from one department to another in an organization. Transfer price should satisfy the following criteria:-
1. It should help establish the profitability of each division or department and
2. It should permit and encourage maximistion of the profits of the company as a whole, rather than of individual departments.
Three methods of transfer pricing
Market price basis: Under this method, the market price of the commodity transferred is applied for invoicing. The items of expenditure not incurred such as selling, advertising, transportation etc. are reduced from the market price.
Cost basis : Where a market price cannot be determined, such as repair services rendered, it is taken at cost. The draw back is that it cannot establish the efficiency or inefficiency of the department in rendering the service.
Cost-plus basis. Under this method, the goods or services of each department are charged on the basis of actual cost plus a margin by way of profit.
Difference between Perfect Competition and Monopolistic Competition
It is a myth.
Products are homogenous
Market price is the same for all producers.
Advertisement does not help.
It is fact of life.
Products are differentiated.
There are different prices for differentiated products.
Advertisement is necessary to sustain monopolistic competition.