10) monopolistic competition

Question 1

define monopolistic competition

Answer 1

a market that shares some characteristics of monopoly and some of perfect competition

Question 2

define product differentiation

Answer 2

a strategy firms adopt that marks their product as being different from their competitors’

Question 3

characteristics: small/large number of firms?

Answer 3

a large number of firms

Question 4

what does a large number of firms mean in terms of changes in price?

Answer 4

• A price change by one firm will have negligible effects on demand for rivals’ products because market share of each firm is low

Question 5

how many firms?

Answer 5

no dominant firms, No firm has significantly more power than others

Question 6

are there barriers to entry?

Answer 6

No (or low) barriers to entry

So if incumbent firms are making SNP, new entrants will be attracted and try to make their product slightly different (product differentiation)

Question 7

are the goods homogenous or heterogenous?

Answer 7

Product differentiation

• Firms’ products are slightly different to competitors’ in some way

Question 8

why is there brand loyalty?

Answer 8

Consumers perceive non-price differences among products leading to brand loyalty

Question 9

how do firms maintain brand loyalty?

Answer 9

• Firms advertise to maintain brand loyalty

Question 10

are there substitutes?

Answer 10

• Products in the market are fairly close substitutes

Question 11

is demand price elastic or inelastic because goods are fairly close substitutes

Answer 11

• So demand is usually relatively price elastic (and more elastic the smaller the differences between products - and the better substitutes they are)

Question 12

why is there a downward sloping demand curve?

Answer 12

A reduction in price would increase quantity demanded, so firms have some control over price. This is due to the price making power afforded by product differentiation

Question 13

monopolistic competition, short run analysis: what are their objectives?

Answer 13

run. Firms are assumed to profit maximise, so produce at MC=MR leading to output Qo at a unit cost of ACo and price Po.
Po-ACo is the supernormal profit per unit, so the shaded rectangle Qox (Po-ACo) is the total SNP.

Question 14

monopolistic competition, short run analysis: barriers to entry

Answer 14

Due to low barriers to entry, this SNP will attract new firms which will produce differentiated products; so this supernormal profit can only be earned in the short run.

Question 15

monopolistic competition, long run analysis: why do the demand curves shift left?

Answer 15

Firms were attracted by the supernormal profits made by incumbent firms and were able to enter the market due to low barriers to entry. These new entrants cause established firms’ demand curves to Shift to the left as market demand is split between more firms.

Question 16

monopolistic competition, long run analysis: what do incumbent firms do when there is increased competition?

Answer 16

increasing their spending on advertising, raising the average cost at all levels of output, shifting up the AC curve.

Question 17

monopolistic competition, long run analysis: due to increased competition, what happens?

Answer 17

The combined impact is that competition in the long run competes away all the supernormal profit, leaving only normal profit and there is no further incentive for more firms to enter the market.

Question 18

what are the 3 advantages of monopolistic competition?

Answer 18

1) Competition lowers prices and increases choice for consumers
2) Lower x-inefficiency
3) advertising informs consumers

Question 19

advantages: monopolistic competition: lowers prices and increases choice

Answer 19

Competition lowers prices and increases choice for consumers
(like perfect competition)

• In the long run new entrants competing drives down prices for consumers because lower barriers make market entry possible. It also increases choice, increasing utility as consumers buy the product that best reflects their preferences

Question 20

advantages: monopolistic competition: lowers x-inefficiency

Answer 20

Competition disciplines firms leading to less X-inefficiency than under a more complacent monopolist

Question 21

advantages: monopolistic competition: advertising

Answer 21

Advertising informs consumers

• High level of advertising ensures consumers are informed about products available

preventing information failure if informative

Question 22

what are the 4 disadvantages of monopolistic competition?

Answer 22

1) no economic efficiency
2) advertising spending is wasteful
3) unable to fully exploit economies of scale
4) Lack of profit in the long run

Question 23

disadvantages: monopolistic competition: no economic effieciency

Answer 23

• Not productively efficient because not producing where AC=MC (bottom of AC curve), and AR (price) does not equal MC so not allocatively efficient either in either the short run or the long run

like Monopoly

Question 24

disadvantages: monopolistic competition: advertising spending is wasteful

Answer 24

To get and maintain brand loyalty, firms advertise heavily. The SNP spent on advertising would be better used on investing in the factors of production to improve the quality of products, as this would increase consumer utility

advert doesn’t particularly make society better off

Question 25

disadvantages: monopolistic competition: unable to fully exploit economies of scale

Answer 25

The ease of entry, and number of firms, means that the typical firm is unlikely to be fully exploiting the economies of scale that are possible leading to higher prices for consumers than could otherwise be achieved

Question 26

disadvantages: monopolistic competition: lack of profit in the long run

Answer 26

less to invest in R+D, lowering dynamic efficiency

Question 27

is monopolistic competition an accurate market condition?

Answer 27

The assumptions underpining monopolistic Competion may
be unrealistic and not reflect market conditions in the real world.

Question 28

to what extent is monopolistic competition beneficial?

Answer 28

depends on the characteristics of the product, as this determines the extent to which the opportunities for economies of scale have been achieved or foregone.

like simple products are not missing out on economies of scale, no a natural monopoly