9.6 - Monopolostic Competition Flashcards
What are the characteristics of monopolistic competition?
Monopolistic competition is characterized by many sellers competing with each other in the market. Goods and services produced are slightly differentiated, giving firms some degree of pricing power, but not to the same extent as monopolies. There are low barriers to entry and exit for firms, meaning that short-run supernormal or subnormal profits will not be sustained in the long run. Firms compete on non-price factors such as branding and advertising to increase their market share. Both firms and consumers are rational decision-makers, with firms maximizing profits and consumers maximizing utility.
What is the implication of goods and services produced being slightly differentiated in monopolistic competition?
Goods and services produced in monopolistic competition are slightly differentiated, allowing firms to have some degree of pricing power. However, there are many other firms selling similar products, which limits the ability of each firm to increase prices too high without losing market share. As a result, the demand curve for a monopolistically competitive firm is relatively more price elastic than that of a monopoly.
How do low barriers to entry and exit affect firms in monopolistic competition?
In monopolistic competition, there are low barriers to entry and exit for firms. This means that if firms are attracted by supernormal profits, they can enter the market with ease. Similarly, if firms want to leave due to losses being made, they can exit without difficulty. As a result, short-run supernormal or subnormal profits will not be sustained in the long run.
What non-price factors do firms compete on in monopolistic competition?
In monopolistic competition, where goods produced are only slightly differentiated from those of other suppliers, firms compete strongly on non-price factors such as branding and advertising. By doing so, firms aim to develop a loyal customer base and increase their market share over time.
How do firms and consumers behave in monopolistic competition?
Firms in monopolistic competition are profit maximizers and produce where marginal cost equals marginal revenue at all times. Consumers, on the other hand, are utility maximizers and consume only up to the point where price equals their marginal utility.
Monopolistic Competition Firm Behaviour - Diagram
In the short run a profit maximising monopolistically competitive firm will produce where MC=MR, with output at Q1 and price of P1. At this point of production, AR>AC with supernormal profits being made indicated by the shaded area. The price making power of the firm, due to slightly differentiated goods being made, allows supernormal profits to exist in the short run. This cannot be sustained in the long run however due to supernormal profits acting as an incentive for new firms to enter the market and low barriers to entry allowing this to actually take place. This shifts the demand curve for the individual firm to the left, a process that keeps happening until AR is tangential to AC and normal profit is being made. The firm has now reached a long run stable equilibrium, profit maximising at normal profit with price P2 and quantity Q2. Long run in monopolistic competition is therefore defined by normal profit.
What is the allocative efficiency of monopolistically competitive firms in the long run?
Monopolistically competitive firms produce outcomes that are allocatively inefficient in the long run. This is because they charge prices greater than marginal cost at the profit-maximizing level of output, which results in resources not being allocated according to consumer demand. Consumers end up with a lower quantity than they desire, their choice is restricted, and prices are high, reducing consumer surplus in the market.
Why are firms in monopolistic competition productively inefficient in the long run?
Firms in monopolistic competition are productively inefficient in the long run because they do not produce at the minimum point on the average cost curve, choosing instead to voluntarily forgo some economies of scale. Although output could be increased further with lower average costs, firms do not do so as it does not correspond with profit maximization, where marginal revenue equals marginal cost. As a result, consumers suffer from higher prices and lower consumer surplus than if all economies of scale were exploited.
How does monopolistic competition impact dynamic efficiency in the long run?
In the long run, dynamic efficiency is not achieved in monopolistic competition, as supernormal profits are not being made. This restricts a monopolistically competitive firm’s ability to reinvest back into the business and develop new technology and innovative new products. Consumers lose out with no technology advances or innovative new products, reducing their choice and also preventing price falls in the future. For producers, their profit-making potential reduces without research and development (R&D) and new product launches, which could have been patentable, providing monopoly power. New products could have increased market share, crucial in a competitive industry where the only way to get ahead of rivals is through innovation and R&D. Better technology could have allowed a firm to reduce their costs of production and thus become more profitable over time.
What is a counterargument to the claim that firms in monopolistic competition are allocatively inefficient in the long run?
The allocative inefficiency of firms in monopolistic competition arises out of consumer demand for differentiated goods. Consumers are willing to pay slightly higher prices than marginal cost for product variety and greater choice, preferring this over the product homogeneity of perfect competition, even though there is static efficiency and lower prices in perfect competition. Furthermore, with many other sellers in the market offering similar if not identical goods, the price exploitation is slight, and much less than in a monopoly. The loss of consumer surplus is therefore much less of a concern. Consumer service and product quality are likely to also be much better in monopolistic competition given the non-price competition drive that exists. Allocative inefficiency in this sense is purely theoretical; consumers actually gain from greater satisfaction in monopolistic competition.
How is the claim that firms in monopolistic competition are productively inefficient challenged?
The productive inefficiency of firms in monopolistic competition arises from consumer demand for differentiated goods, making it harder to achieve productive efficiency and exploit full economies of scale. However, this does not translate into significantly higher prices than in perfect competition, and the loss of efficiency is not as significant as that in a monopoly. Consumers are still willing to pay the higher prices without suffering from large losses in consumer surplus, enjoying the variety and choice that firms in monopolistic competition provide.
What is a counterargument to the claim that firms in monopolistic competition are dynamically inefficient in the long run?
The notion that firms are always dynamically inefficient due to a lack of supernormal profit in the long run may not hold in reality. Firms may be forced to reinvest short-run supernormal profits or even long-run normal profits in order to stay ahead of rivals and compete in such a fiercely competitive market. This will also be in the firm’s long-term interest as it gives them an element of monopoly power, which they can exploit to increase their profits over time. Consumers also benefit from new technology and innovative new products, with prices potentially falling over time. Despite the theory suggesting that monopolistic competition produces the most inefficient outcomes for society, the reality is actually the opposite. It can therefore be argued that monopolistic competition is the best market structure for maximizing social welfare, meeting the needs and wants of consumers that demand variety while providing excellent profit-making incentives for producers.
