You are on page 1of 22

Monopolistic Competition

Lecture Plan

Introduction

Features of Monopolistic Competition

Identification of industry

Demand and Marginal Revenue Curves of a Firm

Price and Output Decisions in Short Run

Price and Output Decisions in Long Run

Monopolistic Competition and Advertising

Comparison between Monopolistic Competition, Monopoly and Perfect Competition

Objectives

To understand the nature of imperfect competition or

monopolistic competition.

 

To

analyze

the

pricing

and

output

decisions

of

a

monopolistically competitive firm in the short run and

long run.

 

To comprehend why a firm in monopolistic competition operates with excess capacity.

To understand the rationale behind advertising for the “unique” product of a monopolistically competitive firm.

Introduction

Introduced by Joan Robinson (The Economics of Imperfect Competition, 1933) and Edward H. Chamberlin (The Theory of Monopolistic Competition, 1933)

It is a market situation in which a relatively large number of producers offer similar but not identical products.

A combination of perfect competition and monopoly.

Imperfect competition because a large number of sellers sell heterogeneous or differentiated products and buyers have preferences for specific sellers.

Monopolistic, because each of these sellers makes the product unique by some differentiation and has control over the small section of market, just like a monopolist.

Brands of toothpastes in India

Colgate: offers all round dental protection Promise: first to highlight the adv of clove oil Close up: (1 st gel toothpaste to be launched in India),offers goodness of milk calcuim

Meswak: offers ayurvedic content

Babool: features natural toothpaste containing

ayurvedic

and medical benefits of babool tree

Apparels industry

Van Huesen :offers “workwear

John Millers: offers cool pant range of trousers to keep you cool

Raymonds :offes “Formal is not boring” range

Allen Solly: boasts of light colours and eco- friendly formal men’s wear

Arrow: tragets professional power dressing And the list goes on n on!!!!!!!!!!!

Features of Monopolistic Competition

Chamberlin:

“Monopolistic competition is a challenge to the traditional viewpoint of economics that competition and monopoly are alternativesBy contrast it is held that most economic situations are composites of both competition and monopoly.

Features:

Large number of buyers and sellers: ..

Heterogeneous products.

A differentiated product enjoys some degree of uniqueness in the mindset of customers, be it real, or imaginary.

Selling costs exist

Independent decision making.

Imperfect knowledge.

Unrestricted entry and exit.

Poultry industry: caselet

A good example of how product differentiation can turn a product sold in perfectly competitive market into one in

which a seller is able to exercise some degree of market

power is the case of poultry industry

Poultry industry in India was fragmented, regional and localized with small poultry farms operating, the level of

competition being reasonable even across regions.

The small players gave low priority to quality standards and hygiene.

Godrej Agrovet, started in 1971was the largest producer of animal feed in the country. In 1998,it pioneered the concept of processed chilled chicken by launching the Real Good” brand of chicken.

This was the first time any brand was associated with the poultry industry.

Real Good Chicken was priced higher than the local,

unbranded, frozen or live chickens. It was promoted for its tenderness.

Ad line was “It is more juicy, marinates better and easy to cook”

Hygiene and freshness emphasized by the fact: it was sealed, sold with correct weight and date of packaging printed.

Real Good Chicken created a segment for itself.

It reestablished its position in 2004 to achieve greater acceptance among consumers by driving home the point

“chilled” not “frozen” through TVC.

It soon spread to other parts of South India from Bangalore to Chennai to Hyderabad, Mumbai and Goa

In the eastern part of India “Arambagh Hatcheries,estb in

1973 launched Arambagh Chicken in 1992-93 through aggressive TVC in the afternoon targeting bengali housewives.

It went a step further and introduced fried chicken,

tandoori chicken, kebabs, drumsticks and a whole range of ready to eat items at its specialised retail outlets like mini super markets. Interestingly, these items were sold

for not more than Rs 25 per portion.

Arambagh Hatcheries also attracted a large number of customers interested in buying at the lowest price with

consistent quality and stability of supply

Kenilworth Hotel in Kolkata was one of its earliest big

buyers. The company negotiated long term price

contracts with these large buyers and protected itself from large competitive markets

Arambagh Hatcheries has grown from Rs 8crores in

1992 to Rs 150 crores in 1998

Some other players who entered the market and used product differentiation as a sales strategy are Suzannes of Kerala,

Suguna of Coimbatore and Al Kabir of Chennai

Demand and Marginal Revenue

Curves of a Firm

Price, Revenu e A R M R O Quanti
Price,
Revenu
e
A
R
M
R
O
Quanti

ty

Normal downward sloping demand curve (AR Curve) as all the firms in the industry sell close substitutes.

Demand is highly elastic and slope of demand curve is flatter

If a firm increases the price of its product slightly, it will lose some, but not all of its customers.

if it lowers the price slightly, it will gain some, but not all of the customers of its rivals.

MR curve lies below AR curve

Price and Output Decisions in

Short Run

Joan

Robinson:

Each

firm

has

a

monopoly

over

its

product.

When product is differentiated, firm has some monopoly power.

 

Firms

have

limited

discretion

over

price,

due

to the

existence of consumer loyalty for specific brands.

Negative slope of the demand curve that is instrumental for chances of monopoly profits in the short run.

The reason for supernormal profit in short run, is supplying a product which is differentiated, or at least perceived to

be different by the consumer.

Price & Output Decisions in Short Run

Firm maximizes profit where (i) MR=MC; (ii) MC cuts MR

when MC is rising. Profit maximising output OQ E and Price OP E

Price, Revenu M e, Cost C A C P E B A E A R M
Price,
Revenu
M
e, Cost
C
A
C
P E
B
A
E
A
R
M
R
O
Quanti
Q E
ty

Total revenue = OP E BQ E

Total cost =OAEQ E Supernormal profit =AP E BE since price OP E > OA

(AR>AC)

Price & Output Decisions in Short Run

Firm maximizes profit where (i) MR=MC; (ii) MC cuts MR

when MC is rising. Profit maximising output OQ E and Price OP E

Price, Revenu M e, Cost C A A E C P E B A R M
Price,
Revenu
M
e, Cost
C
A
A
E
C
P E
B
A
R
M
R
O
Quanti
Q E
ty

Total revenue = OP E BQ E

Total cost =OAEQ E Loss =AP E BE since price OP E < OA (AR<AC)

Price & Output Decisions in Long Run

Firm maximizes profit where (i) MR=MC; (ii) MC cuts MR

when MC is rising. Profit maximising output OQ E and Price OP E

Price, Revenu M e, Cost C A C B P E A R M R O
Price,
Revenu
M
e, Cost
C
A
C
B
P E
A
R
M
R
O
Quanti
Q E
ty

Total revenue = OP E BQ E

Total cost =OAEQ E Normal profit = No loss no gain

since AR=AC

Price & Output Decisions in Long Run

Just like perfect competition, in monopolistic

competition too all the firms would earn normal

profits in the long run.

In the long run supernormal profit would attract new firms to the industry till all the firms earn only normal profits.

Losses, will force firms to exit the industry till remaining firms in the market earn only normal

profits.

If all the firms only normal profit there will be no tendency to enter or exit the market.

Monopolistic Competition and

Advertising

Advantages

Since there

are

a

large

number

of sellers, offering

a

unique brand, customers need to collect and process

information on such large number of brands.

 

It

is

more

profitable

to

attract

customers

through

advertising rather than by lowering price.

Advertising induces customers to pay a premium for the particular brand, termed “brand equity” in marketing.

Advertising is to shift the demand curve of one particular firm, at the expense of other firms that are offering similar products.

Monopolistic Competition and

Advertising

Criticism:

Advertising

induces

customers

into

spending

more,

because of the brand, rather than rational factors. A wasteful expenditure that adds no value to the product

Leads to brand confusion in the minds of the consumers.

Advertisements of rival products may even cancel each other, leading to increase in average costs of each firm, without any corresponding increase of sales.

Optimal Level of Advertising

MR derived from advertising=MC of advertising MRA=MCA

Comparison with Monopoly and

Perfect Competition

Firms are in equilibrium and earning normal profit

AR=AC

Price, Revenue, LAC Cost P M E M E M P MC E C C D
Price,
Revenue,
LAC
Cost
P M
E M
E M
P MC
E C
C
D C
P C
D
MC
D
M
Q M
Quantity
Q MC
Q C
O
Comparison with Monopoly and Perfect Competition Firms are in equilibrium and earning normal profit AR=AC Price,

Excess Capacity

Perfect competition: horizontal demand curve (D C ); output Q C ; price P C

Monopolistic competition:

downward sloping highly elastic demand curve (D MC ); output Q MC (< Q C ), at price P MC (> P C ).

Monopoly: downward sloping less elastic curve D M ; output Q M (< Q C and Q MC ), at price P M (>

P C and P MC ).

Monopoly and monopolistically

competitive firm operate at less

than optimum output and

charge a higher price.

Excess capacity due to market imperfections= QC> Q MC >QM

Summary

Most firms compete with each other and have some (if not full) degree of market power. Thus they lie somewhere between the two

extremes of monopoly and perfect competition.

 

Joan

Robinson

of

Cambridge

and

Chamberlin

of Harvard

independently

came

up

with

a

new

concept

of

market, which

Robinson referred to as imperfect competitionand Chamberlin

termed as monopolistic competition.

A monopolistically competitive has features like large number of buyers and sellers, heterogeneous product, selling costs, independent decision making, imperfect knowledge, unrestricted entry and exit.

It is difficult to define an industry in case of monopolistic competition as firms sell differentiated products. Alternatively, we identify groups of differentiated products in this type of market, by clubbing close substitutes from the same industry and regard them as “product groups”.

Summary

Firms under monopolistic competition have a normal demand curve

with

a

negative

slope

because

of

substitution

effect of

heterogeneous products, which are close substitutes of each other.

They may generate supernormal profits or normal profits, or may even incur losses in the short run.

In the long run all firms earn normal profits due to the feature of

unrestricted entry and exit.

 

It is profitable for to attract customers through advertising rather than by lowering the price.

A firm in perfect competition is able to efficiently allocate its resources by maximizing producer and consumer surplus, though a

monopolist and a monopolistically competitive firm operate at less

than optimum output, and charge a higher price.