Monopolistic competition

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Short-run equilibrium of the firm under monopolistic competition. The firm maximizes its profits and produces a quantity where the firm's marginal revenue (MR) is equal to its marginal cost (MC). The firm is able to collect a price based on the average revenue (AR) curve. The difference between the firms average revenue and average cost gives it a profit.

Long-run equilibrium of the firm under monopolistic competition. The firm still produces where marginal cost and marginal revenue are equal; however, the demand curve (and AR) has shifted as other firms entered the market and increased competition. The firm no longer sells its goods above average cost and can no longer claim an economic profit 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). In monopolistic competition firms can behave like monopolies in the short-run, including using market power to generate profit. 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

There are few barriers to entry and exit. and service industries in large cities. the firm maintains spare capacity. in contrast to perfect competition. a monopolistically competitive firm will make zero economic profit. Consumers perceive that there are non-price differences among the competitors' products. Monopolistically competitive markets have the following characteristics: • • • There are many producers and many consumers in a given market. • The long-run characteristics of a monopolistically competitive market are almost the same as in perfect competition. 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). This gives the amount of influence over the market. Textbook examples of industries with market structures similar to monopolistic competition include restaurants. cereal. it can raise its prices without losing all of its customers. clothing. and no business has total control over the market price. Models of monopolistic competition are often used to model industries. shoes. This means in the long run. A firm making profits in the short run will break even in the long run because demand will decrease and average total cost will increase. with the exception of monopolistic competition having heterogeneous products.[1] Joan Robinson also receives credit as an early pioneer on the concept. which has a perfectly elastic demand schedule.economic profit. Contents [hide] • • • • • • • • • • • • • 1 Major characteristics 2 Product differentiation 3 Many firms 4 Free entry and exit 5 Independent decision making 6 Market power 7 Perfect information 8 Inefficiency 9 Problems 10 Examples 11 Notes 12 See also 13 External links [edit] Major characteristics . Unlike perfect competition. and that monopolistic competition involves a great deal of non-price competition (based on subtle product differentiation). This means that an individual firm's demand curve is downward sloping. because of brand loyalty.[2] Producers have a degree of control over price.

motor scooters. no sunk costs and no exit costs. the differences are not so great as to eliminate goods as substitutes. How many firms will an MC market structure support at market equilibrium? The answer depends on factors such as fixed costs. [edit] Many firms There are many firms in each MC product group and many firms on the side lines prepared to enter the market.There are six characteristics of monopolistic competition (MC): • • • • • • product differentiation many firms free entry and exit in long run Independent decision making Market Power Buyers and Sellers have perfect information[3][4] [edit] Product differentiation MC firms sell products that have real or perceived non-price differences. For example. reputation.In fact the XED would be high.[5] MC goods are best described as close but imperfect substitutes. economies of scale and the degree of product differentiation.[5] The goods perform the same basic functions. [edit] Free entry and exit In the long run there is free entry and exit. motor cycles. The differences are in "qualities" and circumstances such as type. In other words each firm feels free to set prices as if it were a monopoly rather than an oligopoly. the function of motor vehilces is basically the same . Technically the cross price elasticity of demand between goods would be positive.The requirements assures that each firm's actions have a negligible impact on the market. cars and SUVs. a firm could cut prices and increase sales without fear that its actions will prompt retaliatory responses from competitors.[9] The theory is that any action will have such a negligible effect on the overall market demand that an MC firm can act without fear of prompting hightened competition. For example. the higher the fixed costs the fewer firms the market will support. [edit] Independent decision making Each MC firm independently sets the terms of exchange for its product. For example.[6] The fact that there are "many firms" gives each MC firm the freedom to set prices without engaging in strategic decision get from point A to B in reasonable comfort and safety. This assumption implies that there are low start up costs.the fewer firms there will be in market equilibrium. Yet there are many different types of motor vehicles. trucks.[7] Also the greater the degree of product differentiation .[8] The firm gives no consideration to what effect its decision may have on competitors. quality.the more the firm can separate itself from the pack . However. There are numerous firms awaiting to enter the market each with its own "unique" product or in pursuit of positive profits and any firm unable to cover its costs can leave the market without incurring liquidation costs. style. appearance and location that tend to distinguish goods. A product group is a "collection of similar products". .

The monopoly power possessed by an MC firm means that at its profit maximizing level of production there will be a net loss of consumer (and producer) surplus. [10] Market power also means that an MC firm faces a downward sloping demand curve. The result is excess capacity. The second source of inefficiency is the fact that MC firms operate with excess capacity. The demand curve is highly elastic although not "flat".[11] Market Structure comparison Numbe Marke Elasticit Product Profit Excess Efficienc Pricing r of t y of differentiatio maximizatio profits y power firms power demand n n condition Perfect Perfectly Competitio Infinite None elastic n Highly Monopolisti elastic c Many Low (long competition run)[14] Relativel Monopoly One High y inelastic None No Yes[12] P=MR=MC[1 Price 3] taker[13] MR=MC[13] Price setter[13] Price setter[13] High[15] Absolute (across industries) Yes/No (Short/Lon No[17] g) [16] Yes No MR=MC[13] [edit] Inefficiency There are two sources of inefficiency in the MC market structure. An MC firm derives it's market power from the fact that it has relatively few competitors. at its optimum output the firm charges a price that exceeds marginal costs. all differentiating characteristics of the goods. Since the MC firm's demand curve is downward sloping this means that the firm will be charging a price that exceeds marginal costs. Market power means that the firm has control over the terms and conditions of exchange. [edit] Perfect information Buyers know exactly what goods are being offered. That is. the MC firm's profit maximizing output is less than the output associated with minimum average cost. First. where the goods are being sold. 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. whether a firm is making a profit and if so how much. An MC firm’s demand curve is not flat but is downward sloping. For a PC firm this equilibrium condition occurs where the perfectly elastic demand curve equals minimum average cost. The firm can also lower prices without triggering a potentially ruinous price war with competitors. competitors do not engage in strategic decision making and the firms sells differentiated product. the good's price. The MC firm maximizes profits where MR = MC.[18] [edit] Problems Economics .[edit] Market power MC firms have some degree of market power. Both a PC and MC firm will operate at a point where demand or price equals average cost. An MC firm can raise it prices without losing all its customers. The source of an MC firm's market power is not barriers to entry since there are none.

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again information gathering is relatively inexpensive. ISBN 0-17-011441-4. the government would have to regulate all firms that sold heterogeneous products—an impossible proposition in a market economy.[19] [edit] Examples In many U. because the brands are virtually identical. ^ Joshua Gans. Toothpastes and toilet papers are examples of differentiated products.britannica. N. A monopolistically competitive firm might be said to be marginally inefficient because the firm produces at an output where average total cost is not a minimum. to select the best out of many brands the consumer must collect and process information on a large number of different brands. Gregory Mankiw (2003). [edit] Notes 1. heretofore. In a perfectly competitive industry. Encyclopedia Britannica. not observed.Fascism · Georgism Islamic · Laissez-faire Market socialism · Mercantilism Protectionism · Socialism Syndicalism · Third Way The economy: concept and history Business and Economics Portal This box: view • talk • edit While monopolistically competitive firms are inefficient. Evidence suggests that consumers use information obtained from advertising not only to assess the single brand advertised. markets. or simply claiming to have superior products based on brand images and/or advertising. Faced with a monopolistically competitive industry. A monopolistically competitive market might be said to be a marginally inefficient market structure because marginal cost is less than price in the long run. This is disputed by defenders of advertising who argue that (1) brand names can represent a guarantee of quality. Thomson Learning. In many cases. and (2) advertising helps reduce the cost to consumers of weighing the tradeoffs of numerous competing brands. . Principles of Economics. There are unique information and information processing costs associated with selecting a brand in a monopolistically competitive environment. producers practice product differentiation by altering the physical composition. using special 2. In a monopoly industry. the consumer is faced with a single brand and so information gathering is relatively inexpensive. Stephen King. http://www. However.[citation needed] Another concern of critics of monopolistic competition is that it fosters advertising and the creation of brand names.S. the consumer is faced with many brands. the cost of gathering information necessary to selecting the best brand can exceed the benefit of consuming the best brand (versus a randomly selected brand). ^ Monopolistic Competition. it is usually the case that the costs of regulating prices for every product that is sold in monopolistic competition by far exceed the benefits. Critics argue that advertising induces customers into spending more on products because of the name associated with them rather than because of rational factors. Robin Stonecash. as well as to infer consumer satisfaction with brands similar to the advertised brand. but also to infer the possible existence of brands that the consumer has.

2005. Microeconomics 7th ed.joep. page 443. R & Collinge. Nelson. ^ Colander. page 427 Prentice-Hall 2001. It is the point where the LRATC curve "begins to bottom out. ^ Pindyck. J: Microeconomics Theory & Applications with Calculus page 485. 16. T: Microeconomics in Context 2d ed. Wiley 2003. J: Microeconomics Theory & Applications with Calculus page 445. R: Microeconomics page 280 Pearson 2003 15. 17. 7. McGraw-Hill" . R & Rubinfeld. Worth 2009. D: Microeconomics 5th ed. 14. ^ Samuelson. R: Microeconomics pages 224-25 Pearson 2003 13. 10. Pearson 2008. ^ a b c d e f Perloff. N. ^ Perloff. McGraw-Hill 2008.wikipedia. [edit] See also • • • • • • Atomistic market Imperfect competition Microeconomics Monopolistic competition in international trade Perfect competition Simulations and games in economics education Monopolistic Competition by Elmer G. ^ Goodwin. page 317 Sharpe 2009 4. M. J. 9. J: Microeconomics Theory & Applications with Calculus pages 483-84. Pearson 2008. D: Microeconomics 5th ed. Sharpe 2009 12. ^ Pindyck. Journal of Economic Psychology 26: 797–826. page 425 Prentice-Hall 2001. N. 19. R & Collinge. page 289. Ackerman. ^ Antony Davies & Thomas Cline (2005). Pearson 2008 8. T: Microeconomics in Context 2d ed. "A Consumer Behavior Approach to Modeling Monopolistic Competition". Managerial Economics 4th ed. R & Rubinfeld. Microeconomics 7th ed. ^ Goodwin. 11. ^ The firm has not reached full capacity or minimum efficient scale. Minimum efficient scale is the level of production at which the long run average cost curve first reaches its minimum. David C. Ed. F & Weissskopf. ^ Hirschey. Page 283. J. 6.05. R & Rubinfeld. Ackerman. S: 379. ^ Colander." Perloff. Page 283. Managerial Economics Rev. J: Microeconomics Theory & Applications with Calculus page 483 Pearson 2008. ^ Perloff. ^ Ayers. page 424 Prentice-Hall 2001. W & Marks. Wiens [edit] External links • Retrieved from "http://en.3.1016/j.003. D: Microeconomics 5th ed. ^ Pindyck. F & Weissskopf. 5. Nelson. ^ Ayers. ^ a b Krugman & Wells: Microeconomics 2d ed. doi:10. David C. Dryden 2000. 18.

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