LS11 - Monopolistic Competition Flashcards
What are the characteristics of monopolistic competition?
- many small firms
- similar goods, slightly differentiated through quality, branding, or advertising
- low barriers to exit and entry
- firms can set prices to an extent as they are producing goods which are slightly different from the rival firms
Who are some theorists associated with monopolistic competition?
The theory of monopolistic competition, introduced by Edward Chamberlin and Joan Robinson in the 1930s, explains markets that are neither monopolies nor perfectly competitive.
Give an example of a monopolistic market
The chicken takeaway market:
- Product Differentiation: Various establishments offer distinct chicken dishes, catering to different tastes.
- Many Sellers: Numerous chicken takeaways compete in urban areas, providing consumers with ample choices.
- Branding and Marketing: Each takeaway develops a unique identity through branding and promotional strategies.
- Consumer Choice: Customers can choose based on taste, price, and service, reflecting competitive dynamics.
- Low Barriers to Entry: New businesses can easily enter the market, promoting ongoing competition.
Explain the importance of product differentiation in a monopolistic market
- firms face downwards sloping demand curves so they compete by making their products unique. This fosters brand loyalty, allowing firms to influence prices.
- Heavy advertising plays a crucial role in maintaining this loyalty and is prevalent in such markets. Products serve as substitutes, resulting in relatively elastic demand, it is not perfectly elastic, unlike in perfect competition.
Explain the importance of freedom of entry in a monopolistic market
Low or no barriers to entry in the market allows new firms to join when they see existing companies earning supernormal profits. New entrants often seek to differentiate their products slightly. This aspect contrasts with the monopoly model, where significant barriers exist.
Explain the importance of low concentration in a monopolistic market
The market typically has a low concentration ratio due to the presence of many firms. As a result, price changes by one firm have minimal impact on competitors’ demand. This feature distinguishes the market from an oligopoly, where a few firms strategically interact with one another.
What are the three conditions under which a firm is able to price discriminate?
1) The firm must have market power. - Monopoly power.
2) The firm must have information about consumers and their willingness to pay - and there must be identifiable differences between consumers (or groups of consumers).
3) The consumers must have limited ability to resell the product.
What is perfect price discrimination?
This rare situation occurs when a seller can charge each consumer the maximum they are willing to pay. While it’s uncommon in most markets, it can be seen in art or fashion, where prices are often negotiable.
What is partial price discrimination?
This can occur in scenarios like student discounts or senior fares, where different consumer groups pay different prices for the same product. This is referred to as third-degree price discrimination.
What factors impact the ability for a monopolistic firm to discriminate on price?
Market Power: Price discrimination can only occur in markets where firms have some degree of market power, as sellers in perfectly competitive markets must charge the prevailing market price.
Information: For price discrimination to be effective, firms need to identify consumer groups with varying willingness to pay, as different consumers have different sensitivities to price.
Ability to Resell: Price discrimination is not feasible if consumers can easily resell the product. If low-priced consumers could buy products and resell them at a profit, the firm would lose its ability to maintain high prices for other consumer segments. For example, in cases like student discounts or senior citizen concessions, firms can target specific groups, and products like bus rides or dental services cannot be resold.
Describe a case study which exemplifies price discrimination
NAPP Pharmaceutical Holdings engaged in extreme price discrimination, leading to a £3.2 million fine from the Office of Fair Trading (OFT). The company sold sustained-release morphine tablets and capsules in the UK, primarily for patients with incurable cancer. Recognizing market segmentation, NAPP sold the drugs at a 90% discount to hospitals, which drove competitors out of the market and allowed NAPP to monopolize that segment. This strategy enabled NAPP to raise prices for drugs prescribed by GPs, maximizing profits. Following an investigation, the OFT fined NAPP and ordered it to cease these practices, ultimately saving the NHS £2 million annually.
