economics for managers - session 13

8/3/2019 Economics For Managers - Session 13

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PSG INSTITUTE OF MANAGEMENT

MBA 2011-13 BATCH

I TrimesterSession XIII- For Batch C and D

Markets and Competition- Monopolistic Competition

26/09/11EFM faculty P.Uday Shankar1

ECONOMICS FOR MANAGERS


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What is MonopolisticCompetition ? Pure monopoly and perfect competition are

two extreme cases of market structure. In reality,there are markets having large number ofproducers competing with each other in order tosell their product in the market. Thus, there ismonopoly on one hand and perfect competitionon other hand. Such a mixture of monopoly andperfect competition is called as monopolisticcompetition. It is a case of imperfect competition.

The credit of introducing MonopolisticCompetition goes to American Economist Prof.Edward Chamberlin, who had described it in hisbook 'Theory of Monopolistic Competition'published in 1933.

26/09/11

2 EFM faculty P.Uday Shankar


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Competition?


As the name monopolistic competition suggests,

the industry shares characteristics of both aperfectly competitive industry and a monopoly.Like perfect competition, a monopolisticcompetitive industry has many firms, or if thereare not many firms, there are at least manycompeting products that are almost identical innature.

Consider the Laptop industry. There are severalmajor producers of Laptops (e.g. Toshiba, HP,

DELL, ACER, HCL) and each produces a laptopand many other variations that can fit theconsumers desire. In addition, there are a goodnumber of smaller specialty brands that produce

laptops such as Apple.


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Monopolistic Competition- Characteristics


1. No.of sellers: There are large number of sellers

producing differentiated products. So, competitionamong them is very keen. Since number of sellers islarge, each seller produces a very small part of marketsupply. So no seller is in a position to control price ofproduct. Every firm is limited in its size.

2. No.of buyers: They are also large in number and have athe choice of a variety of substitutes of a product.

3. Product Differentiation: It is one of the most importantfeatures of monopolistic competition. In perfectcompetition, products are homogeneous in nature. Onthe contrary, here, every producer tries to keep hisproduct dissimilar than his rival's product in order tomaintain his separate identity. This boosts up thecompetition in market. So, every firm acquires some

monopoly power.


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4. Freedom of Entry and Exit: There are minimal barriersto entry of sellers. The goods and services produced are

easy to replicate by other firms that represent potentialcompetition. If economic profits are present, new firmswill enter into the industry. Entry of new firms happensmostly in the long run.

5. Selling Cost: It is a unique feature of monopolistic

competition. In such type of market, due to productdifferentiation, every firm has to incur some additionalexpenditure in the form of selling cost. This costincludes sales promotion expenses, advertisementexpenses, salaries of marketing staff, etc. But on

account of homogeneous product in perfect competitionand zero competition in monopoly, selling cost does notexist there.

6. Interdependence among sellers: Large numbers of firmsare different in their size. Each firm has its own productionand marketing policy. So no firm is influenced by other firm.All are independent.


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7. Demand Curve: In monopolistic competition, a firm isfacing 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 havingconsiderable 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 existedduring the short run) decrease with the competition. Themarket then behaves more like in the perfect competitionwhere firms cannot gain economic profit.

10. Behaviour of the Consumer: If consumers lack rationality and

innovativeness in choosing the products and if heuristics isrequired to determine consumer choice the market will fallunder natural monopoly (in the absence of governmentregulation/control).


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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 competitivefirm. As in the case of a perfectly competitivefirm or a monopoly, the monopolisticallycompetitive firm produces at a profit

maximizing level of output where marginalcost equals marginal revenue (Point A). Thefirm finds the price it will charge customersat the profit maximizing level of output (Q*)from the demand curve at Point B, and setsprice to P*. As we can see from the shadedregion, the firm is earning economic profitssince price exceeds average total cost at theprofit maximizing level of output.


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Monopolistic Competition- Short Run Profit and Loss



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Run



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Monopolistic Competition- Long Run


Unlike a monopoly industry, new firms can enter

the monopolistically competitive industry. And likea perfectly competitive industry, economic profitsattract new firms seeking a share of those profitsinto the industry. The long run outcome for the

monopolistically competitive firm is zero economicprofits.

This is shown in the figure above. Demand shrinksfrom D0 to D1 eventually settling at a point where

the demand curve is tangent to the average totalcost curve, resulting in zero economic profits(Point B). Note that the marginal revenue andmarginal cost curves are excluded from the figure

to make the presentation clearer.


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As we can see from the figure above, unlike a

perfectly competitive firm that produces at theminimum point of its average total cost curveand where price equals marginal cost, themonopolistically competitive firm does not

produce at an economically efficient point in thelong run. This does not mean to say thatmonopolistic competition is undesirable incomparison to perfect competition. Consumers

value choice, and monopolistic competitionoffers variety in good or service. In contrast,perfectly competitive firms produce a generic,homogenous product offers consumers no

product differences.


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Monopolistic competition also encourages

continuous product innovation. Innovativefirms that introduce new or better productsgain an edge, increase market share and canrealize extra profits while their competitors

attempt to catch up. A key to success formany firms in monopolistically competitiveindustries, especially in the informationtechnology area, is constant innovation tomaintain and expand market share.


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Thanks


http://spot.colorado.edu Thanks for the graphs andmaterial.
http://spot.colorado.edu/http://spot.colorado.edu/

economics for managers - session 13

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