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MONOPOLISTIC COMPETITITION Marshalls perfect competition was an illusion. Mrs.

Robinsons imperfect competition and monopoly were also away from reality. Pure monopoly is a myth. Seller can claim monopoly only and only if he has command over buyers choice. No seller can have such a control because buyers have an alternative to buying. Not buying. So long as that option exists, monopoly remains a myth. In mid 1930s, Prof. Chamberlin developed his theory of monopolistic competition. He pointed out the Marshalls assumption of large number was not the reason that made a seller a price taker. In practice there may be a reasonably large number of sellers in a market. They become price makers because they have an identity that they create and preserve. Chamberlin dropped the assumption of homogeneity of product and perfect knowledge to develop his theory. Chamberlin defined a product in a different way. He said that a product is a bundle of satisfaction. Anything that changes the satisfaction of the buyers would change the value of the product. He introduced the concept of product differentiation He argued that a large mass of product is differentiated by quality, quantity, size, shape, surrounding under which the product is sold, methods of selling and the like. Even the image of the seller and the locational factors would be a part of product differentiation. In perfect competition, buyers and sellers came together as a matter of chance. Chamberlin argued that in practice buyers and sellers come together as a matter of choice. Product differentiation creates a preference in the minds of the buyers. Buyers preference may be real or perceived. So long as buyers have a choice and a preference, the seller can create such preference for his product ane to the extent such preference has been created, the seller enjoys a monopoly of sort. How so ever little a seller be, he controls a group of buyers through the preference created in their minds and hold on to them. So far as they are concerned, he is monopolist. Every seller despite the limited monopoly he may enjoy has to compete on three fronts. He has to retain his buyers, he has to compete to get competitors buyers and he has to try to get as many of the new buyers as is possible. All markets have such competition monopolist. Chamberlin calls the market structure monopolistic competition. Chamberlin also drops the Marshalls assumption of perfect knowledge. With product differentiation, the seller will have to inform the buyers of he is different. The modern day sales promotion, brand building and advertising involve large expenditure. Such selling costs had no place in economics of perfect or imperfect competition. Chamberlin was the first to recognize the need for and power of selling costs.

Individual Pricing under Monopolistic Competition: Chamberlin argued that for deciding the price and output, MR and MC were not required. By fitting between the AR and AC the area of maximum profits, the seller under monopolistic competition will decide his price at the level where his profits are at a maximum. This is shown in the following diagram.

In the above diagram, PM is the equilibrium price giving rectangle PQRN maximum profits. Any other price higher or lower would give less than rectangle PQRN profits. PM is essentially monopoly price. Seller has, through product differentiation and selling cost created strong preference in the minds of the buyers giving him maximum profits. Group Equilibrium: Chamberlin introduces a dynamic concept of group equilibrium. His group is a group of competing monopolists who have established a market presence and identity through product differentiation and selling cost and who compete with each other to retain and enhance their market presence and share. For analytical purpose, he makes the assumption that AR and AC of all sellers in the group are identical. There is product differentiation but based on the preference created, market is evenly divided and so each one has similar AR. Again the differentiation is not such as would lead to

difference in cost. Some seller may spend on improving product and attract the buyers who prefer quality. Others may spend on improving the surroundings attracting the buyers who prefer comfort. The following diagram gives the group equilibrium under monopolistic competition.
Objective All Will Follow P d1 P2 N1 R d3 R2 Q Q2 d1 P4 P3 P1 Subjective others Will Not Follow d

d N

Q1 R1

AR O M M1 T M1

d3

The black AR is the real AR. Chamberlin calls it objective demand and reflects the reality of demand at various prices when all the sellers in the group follow the price change. With given AC, initial equilibrium is at point P where the seller makes maximum profit equal to the rectangle PQRN. This is really the monopoly profit. Competitive urge to make more profit may lead one seller to consider a situation represented by the subjective demand curve. The seller may dream that if he reduces a price and others do not, the demand would be more elastic (responsive). He has reason to believe that others may not. The market is large. Others may lose a few buyers and may not know the loss but the seller who has reduced the price will get a large number of buyers. Red line represents the subjective demand curve. At P the seller may contemplate reducing price to P1M1. If others do not follow, his sales would rise from OM to OM1, his profits to rectangle P1Q1R1N1. He would be tempted to do so and will do so.

In a group, however, what is true for one is true for all. A may think that if he reduces the price and others do not, B thinks if he reduces the price and others do not and so. Chances are that all will reduce the price. The dream is broken and reality dawns. Instead of finding himself at P1 on the subjective demand, the seller would find him at P2 on objective demand curve. Sales have increased at lower price from OM to OM2 and profit at P2Q2R2N2 is lower than the original monopoly position of PQRN. The group of competing monopolist may settle at P2 or may not. Another round price cutting may take place with if I do and others dont assumption. The red subjective demand will slide down the black objective demand. Wanting to go to P3 he may find himself on real demand at P4 and so on. The more the sellers in the group compete, the lower will be the price and lower profits. The slide of the subjective demand down the objective demand will continue till it becomes tangent to AC at A. Now even if others do not follow, any further price reduction will give losses and seller would desist from further price reduction. Chamberlin does not talk of the price under monopolistic competition. He draws the upper and the lower limit for price to settle down between. The price will not be higher that PM, the monopoly price giving monopoly profit PQRN. It will not be lower than AT, the competitive price where the price is equal to AC and the seller is making the competitive normal profit which is included in the AC as his opportunity cost. The price in reality will be at different level for different sellers. Monopolistic competition has two elements monopoly and competition. It the monopoly element is strong, if the seller has created significant preference in the minds of the buyers, if he enjoys customer loyalty through product differentiation and selling cost, his price will tend towards higher monopoly price. If the seller does not have a significant identity, if his is me too product, if he has not created significant preference, his price would tend to be lower competitive price and he will make normal profits equal to his opportunity cost.