MONOPOLISTIC COMPETITION

vikram chawla

vikram chawla

Vikram Chawla
INTRODUCTION

In discussing industries that are neither monopolies nor p-competitive, economists have tended to begin from the four characteristics of a p-competitive industry. We recall that those characteristics are:



Many buyers and sellers
A homogenous product
Sufficient knowledge
Free entry
Competition can be "imperfect" in an industry if the industry deviates from any one of the four. Thus, if there are just a few firms (but more than one), deviating from the first characteristic, the industry is said to be an "oligopoly." Since the nineteen-twenties, economists have also discussed the situation when an "industry" deviates only in the second characteristic. This is called "monopolistic competition," and we have "monopolistic competition" when a group of firms sell closely related, but not homogenous products. Instead, the products are said to be "differentiated products." Thus, the characteristics of "monopolistic competition" are:

Many buyers and sellers
Differentiated products
Sufficient knowledge
Free entry
To say that products are differentiated is to say that the products may be (more or less) good substitutes, but they are not perfect substitutes. For an example of a monopolistically competitive "industry" we may think of the hairdressing industry. There are many hairdressers in the country, and most hairdressing firms are quite small. There is free entry and it is at least possible that people know enough about their hairdressing options so that the "sufficient knowledge" condition is fulfilled. But the products of different hairdressers are not perfect substitutes. At the very least, their services are differentiated by location. A hairdresser in Center City Philadelphia is not a perfect substitute for a hairdresser in the suburbs -- although they may be good substitutes from the point of view of a customer who lives in the suburbs but works in Center City. Hairdressers' services may be differentiated in other ways as well. Their styles may be different; the decor of the salon may be different, and that may make a difference for some customers; and even the quality of the conversation may make a difference. A very good friend of mine changed hairdressers because her old hairdresser was an outspoken Republican. My friend said that she just couldn't take it any more without answering back -- and it's not a good idea to get into a controversy with one's haircutter!


The model is especially useful in explaining the motivation for intra-industry trade, i.e. trade between countries that occurs within an industry rather than across industries. In other words the model can explain why some countries export and import automobiles simultaneously. This type of trade, although frequently measured is not readily explained in the context of the Ricardian or Heckscher-Ohlin models of trade. In those models a country might export wine and import cheese, but it would never export and import wine at the same time.



Main Features of Monopolistic Competition: Monopolistic competition is a modern form of the market. A large variety of goods are sold in such a market. Its main features can be stated as follows:

i) Large Number: The number of firms operating under monopolistic competition is sufficiently large. Moreover there is freedom of entry. There are no quantitative restrictions or differences in market conditions. However, each firm differs from its rivals in some qualitative respect.

ii) Close Substitutes: In case of a monopoly there are no substitutes available. Under monopolistic competition firms produce very close substitutes. Chocolates of one company may serve a similar purpose as that of some other firm. The only difference may be of some variation in the quality of the product.

iii) Group: Firms under monopolistic competition together form a group. They cannot be called an industry. This is because their products are somewhat dissimilar and not homogenous as under competitive industry.

iv) Product Differentiation: Under monopolistic competition products are differentiated. This is the outstanding feature of this form of market. Otherwise monopolistic competition closely resembles perfect competition. The fundamental difference between the two is that products are no more homogenous. Goods produced are deliberately differentiated. By differentiation we mean the goods are made to appear somewhat different and superior to those produced by other firms. Product differentiation may be real or apparent. By real differentiation we mean that a difference is maintained in some physical or chemical composition of a product or in the taste and appearance of that product. This is easily done with the help of attractive packaging; or some extra services are rendered. A product can also be marketed as superior using local advantage. When products are differentiated more buyers are likely to be attracted. Thereby the firm gains extra control over demand and market conditions. The demand curve of a firm will then alter to the advantage of a firm. It will become more flexible and shift upwards. A firm’s capacity to alter the demand curve for its own product is the chief analytical feature of monopolistic competition. Under no other form of market do producers attempt to influence the demand which is entirely based on consumer behavior. Gains of product differentiation have been shown in Figure 49. In the figure dd is the original demand curve that the firm faces before product differentiation.


On this demand curve at market price P the firm sells output Q. When the firm differentiates its product successfully its demand curve alters and is now d1d1. On the new demand curve the firm at point R1 can charge a price as high as P1 and sell old output Q. It could also charge the same price P and sell a very large output Q1 at point R3. Or then the firm could choose a somewhat higher price (higher than P1 but lower than P2) P2 at point R2 and sell a somewhat larger quantity Q2.

(v) Selling (Advertising) Cost: Selling Cost (SC) is another outstanding feature of a monopolistic competitive market. This in the form of advertisement expenditure. Selling Cost and Product Differentiation together enable the producer to maintain some control over market conditions and influence the shape of the demand curve. Both features are interdependent. Whenever a product is differentiated it is necessary to inform buyers; and advertisement is the only medium through which buyers can be told about superiority of that product. Selling Cost by itself is apparent product differentiation. When a product does not contain any genuine qualitative difference, buyers can be made to treat a product differently through advertisements. So whenever products are differentiated and advertised, the market becomes a monopolistic competition. These are the hallmarks of this form of market. The presence of selling cost increases the firm’s cost of production. In order to recover it, firms have to charge a higher price. The net effect of a monopolistic competitive market is pricing goods at a higher rate. Consumers have to bear this extra expenditure.

According to E H CHAMBERLIN ,an american economist ,monopolistic competitionis a market form characterized by both competition and monopoly elements…….the theory…..


Chamberlin’s assumptions: Since products are differentiated under monopolistic competition, the demand curve for a firm alters. The price of an individual firm may be higher and its sales larger. All this calls for stiff reaction on the part of other rival firms. Moreover under monopolistic competition there is freedom of entry and the products are close substitutes. All this makes the market situation highly complex through continuous actions and reactions of the firms. In order to simplify the analysis under such a market, Chamberlin has made certain assumptions. Two of these assumptions deserve special reference. Chamberlin has called them Heroic assumptions.

i) Uniformity Assumption: Both demand conditions and cost conditions, and demand and supply curves are uniform throughout the group for all products produced. This ensures that the ability of a firm to influence buyers is not caused by a difference in the demand or cost structures of the firm. The influence of the firm must arise purely out of its ability to differentiate products.

ii) Symmetry Assumption: Any adjustment made in the price or the product by an individual firm spreads its influence over a large number of competitors. The impact of such adjustments is significant. The net effect of these two assumptions is on the demand curve of a product differentiating firm. Before we proceed with equilibrium analysis let us summarize the monopolistic and competitive elements in this market. Chamberlin has called this market one of monopolistic competition because of the blending of the features of both competition and monopoly.

:SugarwareZ-298:
 
when u have explained the monopolistic competition, lets understand wat is a perfect competition....it wud be better if somebody here can throw in some examples to better understand this important economic concepts:

A perfectly competitive market may have some distinguishing characteristics, including:

* Many buyers/Many Sellers – Many consumers with the willingness and ability to buy the product at a certain price, Many producers with the willingness and ability to supply the product at a certain price.
* Low-Entry/Exit Barriers – It is relatively easy to enter or exit as a business in a perfectly competitive market.
* Perfect Information - Prices are assumed to be known to all consumers and producers.[2] [3]
* Transactions are Costless - Buyers and sellers incur no costs in making an exchange. [4]
* Firms Aim to Maximize Profits - Firms aim to sell where marginal costs meet marginal revenue, where they generate the most profit.
* Homogeneous Products – The characteristics of any given market good or service do not vary across suppliers.


Profit

In contrast to a monopoly or oligopoly, it is impossible for a firm in perfect competition to earn economic profit in the long run, which is to say that a firm cannot make any more money than is necessary to cover its economic costs. In order not to misinterpret this zero-long-run-profits thesis, it must be remembered that the term 'profit' is also used in other ways.

Neoclassical theory defines profit as what is left of revenue after all costs have been subtracted, including normal interest on capital plus the normal excess over it required to cover risk, and normal salary for managerial activity.

Classical economists on the contrary defined profit as what is left after subtracting costs except interest and risk coverage; thus, if one leaves aside risk coverage for simplicity, the neoclassical zero-long-run-profit thesis would be re-expressed in classical parlance as profits coinciding with interest in the long period, i.e. the rate of profit tending to coincide with the rate of interest.

Profits in the classical meaning do not tend to disappear in the long period but tend to normal profit. With this terminology, if a firm is earning abnormal profit in the short term, this will act as a trigger for other firms to enter the market. They will compete with the first firm, driving the market price down until all firms are earning normal profit only.

It is important to note that perfect competition is a sufficient condition for allocative and productive efficiency, but it is not a necessary condition. Laboratory experiments in which participants have significant price setting power and little or no information about their counterparts consistently produce efficient results given the proper trading institutions.


WAITING FOR THE EXAMPLES TO FLOW IN GUYS:SugarwareZ-183:
 
Forms of Competition

Although each form has many aspects, not all of which can be considered here, competition can generally be classified into four main categories: perfect competition, monopolistic competition, oligopoly, and monopoly. (Table 1 summarizes the basic differences among these four types of competition.)

Perfect CompetitionPerfect competition (also known as pure competition) exists when a large number of sellers produce products or services that seem to be identical. These types of businesses are typically run on a small scale, and participants have no control over the selling price of their product because no one seller is large enough to dictate the price of the product. Instead, the price of the product is set by the market. There are many competitors in a perfect competition industry, and it is fairly easy to enter or leave the industry. While there are no ideal examples of perfect competition, agricultural products are considered to be the closest example in today's economy. The corn grown by one farmer is virtually identical to the corn grown by another farmer, and the current market controls the price the farmers receive for their crops. Perfect competition follows the law of supply and demand. If the price of a product is high, consumers will demand less of the product while the suppliers will want to supply more. If the price of a product is low, the consumers will demand more of the product, but the suppliers will be unwilling to sell much at such a low price. The equilibrium point is where the supply and the demand meet and determine the market price. For example, if the going market price for wheat is $5 a bushel and a farmer tries to sell wheat for $6 a bushel, no one will buy because they can get it for $5 a bushel from someone else. On the other hand, if a farmer offers to sell wheat for $4 a bushel, the crop will sell, but the farmer has lost money because the crop is worth $5 a bushel on the open market.

Monopolistic CompetitionMonopolistic competition exists when a large number of sellers produce a product or service that is perceived by consumers as being different from that of a competitor but is actually quite similar. This perception of difference is the result of product differentiation, which is the key to success in a monopolistic industry. Products can be differentiated based on price, quality, image, or some other feature, depending on the product. For example, there are many different brands of bath soap on the market today. Each brand of soap is similar because it is designed to get the user clean; however, each soap product tries to differentiate itself from the competition to attract consumers. One soap might claim that it leaves you with soft skin, while another soap might claim that it has a clean, fresh scent. Each participant in this market structure has some control over pricing, which means it can alter the selling price as long as consumers are still willing to buy its product at the new price. If one product costs twice as much as similar products on the market, chances are most consumers will avoid buying the more expensive product and buy the competitors' products instead. There can be few or many competitors (typically many) in a monopolistic industry, and it is somewhat difficult to enter or leave such an industry. Monopolistic products are typically found in retailing businesses. Some examples of monopolistic products and/or services are shampoo products, extermination services, oil changes, toothpaste, and fast-food restaurants.

Oligopoly An oligopoly (which is described more completely in another article) exists when there are few sellers in a certain industry. This occurs because a large investment is required to enter the industry, which makes it difficult to enter or leave. The businesses involved in an oligopoly type of industry are typically very large because they have the financial ability to make the needed investment. The type of products sold in an oligopoly can be similar or different, and each seller has some control over price. Examples of oligopolies include the automobile, airplane, and steel industries.

Monopoly A monopoly (which is described more completely in another article) exists when a single seller controls the supply of a good or service and prevents other businesses from entering the field. Being the only provider of a certain good or service gives the seller considerable control over price. Monopolies are prohibited by law in the United States; however, government-regulated

Types of Competition

Characteristics Perfect Competition Monopolistic Competition Oligopoly Monopoly
Number of competitors Many Few to many Very few No direct competition
Ease of entry or exit from industry Easy Somewhat difficult Difficult Regulated by U.S. government
Similarity of goods/services offered by competing firms Same Seemingly different but may be quite similar Similar or different No directly competing products
Individual firm's control over price None (set by the market) Some Some Considerable (in true monopoly) Little (in regulated one)
Examples Farmer Fast-food restaurant Automotive manufacturer Power company

monopolies do exist in some business areas because of the huge up-front investment that must be made in order to provide some types of services. Examples of monopolies in the United States are public utility companies that provide services and/or products such as gas, water, and/ or electricity.

hey guys these are the 3 types of competition hope this is helpful if ny other information to add in it do tell
 
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