Monopolistic Competition Flashcards
Explain the key features of monopolistic competition and how they are linked.
1) Number of producers: Large number of small firms relative to market size. Each firm has a relatively SMALL (not insignificant) share of the market and can act independently of the other. No firm attempts to take into account the reaction of all its rivals because it is not only impossible, retaliation by rivals is also less likely to occur as the gain in revenue will be spread thinly across all its rivals. Since the extent to which each rival firm suffers is negligible, each firm is able to determine its price-output policy. MPC firms however prefer to engage in non-price competition (differentiating their products, small scale advertising and promotion) as they are able to maintain customer loyalty and have limited funds to engage in pricing competition.
2) Extent of barriers to entry and exit: Low start-up costs (easy to cope technology, relatively mobile factors of production)
3) Nature of good: Slightly differentiated - many close substitutes available (demand curve is relatively price elastic)
- Real physical differences can be a result of product development and innovation although products serve the same purpose e.g. materials used
- Imaginary differences can be a result of design, packaging, branding and method of promotion which can be achieved through non-price competition such as marketing techniques, advertising. These will allow demand for the firm’s products to be less price elastic and give the firm more leeway in raising prices without fear of loss of market share.
- Differences in conditions of sale is achieved through differences in locations of shops, quality of service
4) Imperfect knowledge about production methods and prices (e.g. secret recipes)
5) Market power: Price setter as sellers still retain some market power due to their differentiated products. However, they have limited ability to set price above its marginal cost - cannot mark up prices significantly.
Explain the SR and LR equilibrium under monopolistic competition. (Profits)
.
Evaluate both the merits and demerits of a monopolistically competitive firm in terms of productive efficiency, allocative efficiency, dynamic efficiency, consumer surplus, choice and equity
Firms in imperfect competition has a downward-sloping DD curve as they are price-setters and hence its AR or price is greater than MC annd at the profit-maximising level, P > MC and are thus allocatively inefficient. However, since it has a much weaker price-setting ability compared to a monopoly, its demand curve is more price elastic and less steep compared to that of a monopoly. Thus, the extent to which P exceeds MC is smaller. While it is allocatively inefficient, it is much less than a monopoly.
Firms in an MPC are productively efficient from their own perspective as they have to operate at a point on the LRAC curve due to their long-run normal profits and being X-inefficient will result in losses and elimination from the industry. (NOTE: All firms in imperfect market structures will not be productively efficient from the firm’s perspective as there are attempts at product differentiation which result in firms producing at a higher than average cost than necessary.
Firms in an MPC have the incentive to innovate but limited ability to do so.
Monopolistic competition enhances consumer sovereignty as consumers can choose who they wish to purchase from and enjoy increased choice and variety of products as a result of product differentiation by firms.
