Monopolistic Comptn Presntn

a presentation on

Monopolistic Competition

Definition

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Monopolistic Competition

may be defined as a market situation in which there are large number of Buyers and Sellers dealing in differentiated products with different prices.

Characteristics of Monopolistic Competition 

1) Existence of many firms 

Industry consists of a large number of sellers, each one of  whom does not feel dependent others.

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Every firm acts independently without bothering about the reactions of the rivals.

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The size is so large that an individual firm has only a relatively small part in the total market, so that each firm has very limited control over the price of the product.

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2) Product differentiation 

Product differentiation means that products are different in some ways, but not altogether so.

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The products are not identical but at the same time they will not be entirely different from each other.

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The product of each firm is different from that of its rivals in one or more respects. Different tooth pastes like Colgate, Close up, Forhans, Pepsodent, etc. provide an example of monopolistic competition.

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These products are relatively close substitutes for each other but not perfect substitutes.

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Consumers have definite preferences for the particular varieties or brands of  products offered for sale by various sellers.

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Advertisement, packing, trademarks, brand names etc, help differentiation of  products even if they are physically identical.

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3) Large number of buyers 

There are large numbers of buyers in the market who have their own brand preferences. So the sellers are able to exercise a certain degree of monopoly over them.

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Each seller has to plan various incentive schemes to retain the customers who patronize his products.

4) Free entry and exit of firms 

As in the perfect competition, in the monopolistic Competition too, there is freedom of entry and exit. That is, there is no barrier as found under monopoly.

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5) Selling costs 

Since the products are close substitutes much effort is needed to retain the existing consumers and to create new demand.

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So each firm has to spend a lot on selling cost, which includes cost on advertising and other sales promotion activities.

6) The group 

Under perfect competition the term industry refers to the collection of  firms producing a homogeneous product. But under monopolistic competition the products of various firms are not identical though they are close substitutes. Prof. Chamberline calls the collection of firms producing close substitute products as a group.

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7) Imperfect knowledge 

Imperfect knowledge about the product leads to monopolistic competition. If the buyers are fully aware of the quality of the product they cannot be influenced much by advertisement or other sales promotion techniques.

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But in the business world we can see that though the quality of certain products is the same, effective advertisement and sales promotion techniques make certain brands monopolistic.

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For example, effective dealer service backed by advertisement helped popularization of some brand of cement though the quality of almost all the cement available in the market remains the same.

under Monopolistic Competition 

Short-Run Equilibrium of the firm 

The firm is in equilibrium when Marginal Revenue= Marginal Cost  Here •AR is the average revenue curve, •MR marginal revenue curve, •SMC short-run marginal cost curve, •SAC short-run average cost

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MR and SMC intersect at point Q where output is OM and price MP (i.e. OP’).

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Thus the equilibrium output or the maximum profit output is OM and the price MP or OP'.

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Here, AR is above AC in the equilibrium point. As AR is above AC, this firm is making abnormal profits in i n the Short-run.

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The super-profit is PT, i.e. the difference between AR and AC at equilibrium point and the total supernormal profit is PT x OM. This total super-profit is represented by the rectangle P'PTT'

PROFIT

•If the demand and cost conditions are less favorable the monopolistic competitive firm may incur loss in the short-run

•A firm incurs loss when the price is less than average cost of production

•MT is the average cost and OP' (i.e. MP) is the price per unit at equilibrium output OM. TP is the loss per unit

•The total loss at an output OM is TP x OM

•The rectangle PP'T'T represents the total loss area in the short-run.

Long-Run Equilibrium of the Firm 

A firm under monopolistic competition cannot make super-profit in the long-run.

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There is no restriction in monopolistic competition as to the entry or exit of  new firms.

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If the existing firms make supernormal profit new firms will enter the industry.

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When more and more new firms enter the industry the price will fall and it will near the average cost.

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The entry of new firms will increase production.But the increase increase in production does not increase sales.

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The new firms as well as existing firms are to share the same market

•Moreover the new firms are to compete with the existing reputed firms. •To compete with the existing reputed firm the new firms introduce their product at a lower price. •Thus the existing firms are also compelled to reduce the price of their product. Now the price tends to equal the average cost. The individual firm will earn only normal profit. •Profits are only normal when average revenue equals average cost. •A monopolistic competitive firm in the long-run will not incur loss. If  the firms incur loss, some firms will leave the industry, thus reducing the total production. •Now the price will again rise sufficiently to cover the average cost of  production.

A firm under monopolistic competition will be in the long-run equilibriums where MC=MR and AC=AR

Here the average cost is not the minimum when the firm is at equilibrium. The monopolistically competitive firm is not an optimum firm. It does not enjoy the full advantage of the economies of large scale production. If an attempt is made to increase production in order to attain the minimum cost of  production per unit it will only result in loss. This is because MC now exceeds MR.

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So in monopolistic competitive industry we can see the existence of too many firms, each producing at a level below I the optimum point or lowest average cost point.

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Thus each firm will face under-utilization of its production capacity. So excess capacity is a feature of the firms under monopolistic competition.

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As the lowest average cost point is not attained, the price fixed by the monopolistic competitive firm will be high.