Monopolistic Comptn Presntn

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Monopolistic

Monopolistic

Competition

Competition

Definition

Definition

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Monopolistic Competition

Monopolistic Competition

_{may be defined as a}

_{may be defined as a}

market situation in which there are large number of Buyers

market situation in which there are large number of Buyers

and Sellers dealing in differentiated products with different

and Sellers dealing in differentiated products with different

prices.

Characteristics

Characteristics

of Monopolistic Competition

of Monopolistic Competition

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_{1) Existence of many firms}

_{1) Existence of many firms}

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_{Industry consists of a large number of sellers, each one of} 

_{Industry consists of a large number of sellers, each one of} 

whom does not feel dependent others.

whom does not feel dependent others.

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_{Every firm acts independently without bothering about the}

_{Every firm acts independently without bothering about the}

reactions of the rivals.

reactions of the rivals.

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_{The size is so large that an individual firm has only a relatively}

_{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

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}

_{2) Product differentiation}

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 _{Product differentiation means that products are different in some ways, but notProduct differentiation means that products are different in some ways, but not}

altogether so. altogether so. 

 _{The products are not identical but at the same time they will not be entirelyThe products are not identical but at the same time they will not be entirely}

different from each other. different from each other. 

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

provide an example of monopolistic competition.monopolistic competition. 

 _{These products are relatively close substitutes for each other but not perfectThese products are relatively close substitutes for each other but not perfect}

substitutes. substitutes. 

 _{Consumers have definite preferences for the particular varieties or brands of Consumers have definite preferences for the particular varieties or brands of} 

products offered for sale by various sellers. products offered for sale by various sellers. 

 _{Advertisement, packing, trademarks, brand names etc, help differentiation of Advertisement, packing, trademarks, brand names etc, help differentiation of} 

products even if they are physically identical. products even if they are physically identical.

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3) Large number of buyers

3) Large number of buyers

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 _{There are large numbers of buyers in the There are large numbers of buyers in the market who have their own brandmarket who have their own brand}

preferences. So the sellers are able to exercise a

preferences. So the sellers are able to exercise a certain degree of monopolycertain degree of monopoly over them.

over them. 

 _{Each seller has to plan various incentive schemes to retain the Each seller has to plan various incentive schemes to retain the customerscustomers}

who patronize his products. who patronize his products.

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4) Free entry and exit of firms

4) Free entry and exit of firms

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 As in the perfect competition, in the monopolistic Competition too, there isAs in the perfect competition, in the monopolistic Competition too, there is

freedom of entry and exit. That is,

freedom of entry and exit. That is, there is no barrier as found there is no barrier as found underunder monopoly.

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_{5) Selling costs}

_{5) Selling costs}

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 _{Since the products are close substitutes much effort is needed toSince the products are close substitutes much effort is needed to} retain the existing consumers and to create new demand.

retain the existing consumers and to create new demand. 

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

advertising and other sales promotion activities.

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_{6) The group}

_{6) The group}

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

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_{7) Imperfect knowledge}

_{7) Imperfect knowledge}

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

promotion techniques. 

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

techniques make certain brands monopolistic. 

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

under Monopolistic

under Monopolistic

Competition

Competition

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_{Short-Run Equilibrium of the firm}

_{Short-Run Equilibrium of the firm}

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_{The firm is in equilibrium when}

_{The firm is in equilibrium when}

Marginal Revenue= Marginal Cost 

Marginal Revenue= Marginal Cost 

•

•AR is the average revenue

AR is the average revenue

curve,

curve,

•

•MR marginal revenue

MR marginal revenue

curve,

curve,

•

•SMC short-run marginal

SMC short-run marginal

cost curve,

cost curve,

•SAC short-run average

•SAC short-run average

cost

cost

Here

Here

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 _{MR and SMC intersect at point QMR and SMC intersect at point Q}

where output is OM and price MP (i.e. where output is OM and price MP (i.e. OP’).

OP’).

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 _{Thus the equilibrium output or theThus the equilibrium output or the} maximum profit output is OM and the maximum profit output is OM and the price MP or OP'.

price MP or OP'.

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 _{Here, AR is above AC in the equilibrium point. As AR is above AC,Here, AR is above AC in the equilibrium point. As AR is above AC,}

this firm is making abnormal profits i

this firm is making abnormal profits in the Short-run.n the Short-run.

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 _{The super-profit is PT, i.e. the difference between AR and AC atThe super-profit is PT, i.e. the difference between AR and AC at}

equilibrium point and the total supernormal profit is PT

equilibrium point and the total supernormal profit is PT x OM. Thisx OM. This total super-profit is represented by the rectangle P'PTT'

total super-profit is represented by the rectangle P'PTT'

PROFIT PROFIT

•

•If the demand and cost conditions are lessIf the demand and cost conditions are less

favorable the monopolistic competitive firm may favorable the monopolistic competitive firm may incur loss in the short-run

incur loss in the short-run

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

average cost of production

•

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

loss per unit

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

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

Long-Run Equilibrium of the

Long-Run Equilibrium of the

Firm

Firm

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 _{A firm under monopolistic competition cannot make super-profit in theA firm under monopolistic competition cannot make super-profit in the} long-run.

long-run. 

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

new firms. 

 _{If the existing firms make supernormal profit new firms will enter theIf the existing firms make supernormal profit new firms will enter the} industry.

industry. 

 _{When more and more new firms enter the industry the price will fall and itWhen more and more new firms enter the industry the price will fall and it} will near the

will near the average cost.average cost. 

 _{The entry of new firms will increase production.But the increasThe entry of new firms will increase production.But the increase ine in} production does not increase sales.

production does not increase sales. 

•Moreover the new firms are to compete with the existing reputed

•Moreover the new firms are to compete with the existing reputed

firms.

firms.

•To compete with the existing reputed firm the new firms introduce

•To compete with the existing reputed firm the new firms introduce

their product at a lower price.

their product at a lower price.

•Thus the existing firms are also compelled to reduce the price of

•Thus the existing firms are also compelled to reduce the price of their

their

product. Now the price tends to equal the average cost. The individual

product. Now the price tends to equal the average cost. The individual

firm will earn only normal profit.

firm will earn only normal profit.

•

•Profits are only normal when average revenue equals average cost.

Profits are only normal when average revenue equals average cost.

•A monopolistic competitive firm in the long-run will not incur loss. If 

•A monopolistic competitive firm in the long-run will not incur loss. If 

the firms incur loss, some firms will leave

the firms incur loss, some firms will leave the industry, thus reducing

the industry, thus reducing

the total production.

the total production.

•

•Now the price will again rise sufficiently to cover the average cost of 

Now the price will again rise sufficiently to cover the average cost of 

production.

A firm

A firm under monopolistic competition

under monopolistic competition

will be in the long-run equilibriums

will be in the long-run equilibriums

where

where

MC=MR

MC=MR

and

and

AC=AR

AC=AR

Here

Here the average cost is not the minimum when the firm is at

the average cost is not the minimum when the firm is at

equilibrium. The monopolistically competitive firm is not an

equilibrium. The monopolistically competitive firm is not an

optimum firm. It does not enjoy the full advantage of the

optimum firm. It does not enjoy the full advantage of the

economies of large scale production. If an attempt is made to

economies of large scale production. If an attempt is made to

increase production in order to attain the minimum cost of 

increase production in order to attain the minimum cost of 

production per unit it will only result in loss.

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 aSo 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. 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. SoThus each firm will face under-utilization of its production capacity. So excess capacityexcess capacity is a feature of theis a feature of the

firms under monopolistic competition. 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 beAs the lowest average cost point is not attained, the price fixed by the monopolistic competitive firm will be

high. high.