WEEK 7 - Chapter 16: Monopolistic Competition Flashcards
What is an oligopoly?
A market structure in which only a few sellers offer similar or identical products.
One example is the market for retail groceries. Two large sellers, Coles and Woolworths, together supply around 70 per cent of all dry groceries sold to Australian consumers.
In choosing how much to produce and what price to charge, each firm in an oligopoly is concerned not only with what its competitors are doing but also with how its competitors would react to what it might do.
Monopolistic competition.
A second type of imperfectly competitive market is called monopolistic competition. This describes a market structure in which there are many firms selling products that are similar but not identical.
In a monopolistically competitive market, each firm has a monopoly over the product it makes, but many other firms make similar products that compete for the same customers.
Examples of monopolistic competition.
A moment’s thought reveals a long list of markets with these attributes – books, music, films, smart phone apps, restaurants, furniture and so on.
Attributes of monopolistic competition.
To be more precise, monopolistic competition describes a market with the following attributes:
. Many sellers: There are many firms competing for the same group of customers (can’t collude because there are too many sellers).
. Product differentiation: Each firm produces a product that is at least slightly different from those of other firms. Thus, rather than being a price taker, each firm faces a downward- sloping demand curve.
. Free entry: In the long run, firms can enter (or exit) the market without restriction. Thus, the number of firms in the market adjusts until economic profits are driven to zero.
The four types of market structure.
Number of firms:
. Many firms - monopoly
. Few firms - oligopoly
. Many firms - monopolistic and perfect competition
Types of products:
. Differentiated - monopolistic competition
. Identical products - perfect competition
Monopolistically competitive firm in the short run.
Each firm in a monopolistically competitive market is, in many ways, like a monopoly.
Because its product is different from those offered by other firms, it faces a downward-sloping demand curve. (In contrast, a perfectly competitive firm faces a horizontal demand curve at the market price.)
Thus, the monopolistically competitive firm follows a monopolist’s rule for profit maximisation – it chooses the quantity at which marginal revenue equals marginal cost and then uses its demand curve to find the price consistent with that quantity.
The profit-maximising quantity is found at the intersection of the marginal-revenue and marginal-cost curves.
When ATC is above D the P is below ATC, meaning there is a loss. When ATC is below D the P is above ATC, meaning there is profit.
Monopolistically competitive firm in the long-run.
When firms are making profits, new firms have an incentive to enter the market. This entry increases the number of products from which customers can choose and, therefore, reduces the demand faced by each firm already in the market.
In other words, profit encourages entry, and entry shifts the demand curves faced by the incumbent firms to the left. As the demand for incumbent firms’ products fall, these firms experience declining profit.
Conversely, when firms are making losses, firms in the market have an incentive to exit. As firms exit, customers have fewer products from which to choose. This decrease in the number of firms expands the demand faced by those firms that stay in the market. In other words, losses encourage exit, and exit shifts the demand curves of the remaining firms to the right. As the demand for the remaining firms’ products rises, these firms experience rising profit (that is, declining losses).
This process of entry and exit continues until the firms in the market are making exactly zero economic profit. Once the market reaches this equilibrium, new firms have no incentive to enter and existing firms have no incentive to exit.
Describe a monopolistic competitor in the long-run.
As in a monopoly market, price exceeds marginal cost. This conclusion arises because profit maximisation requires marginal revenue to equal marginal cost and because the downward- sloping demand curve makes marginal revenue less than the price.
As in a competitive market, price equals average total cost. This conclusion arises because free entry and exit drive economic profit to zero.
Profit-maximising quantity goes through the points where MC and MR intersect. Profit-maximising quantity and P = ATC intersect where D and ATC touch.
Long-run equilibrium: two characteristics.
As in a monopoly, PRICE EXCEEDS MARGINAL COST.
- cost maximisation requires MR to equal MC
- the downward sloping Demand curve makes MR less than P
As in a competitive market, price equals ATC.
- free entry and exist drive ECONOMIC PROFIT TO ZERO.
Monopolistic Vs Perfect Competition.
There are two noteworthy difference between monopolistic and perfect Competition:
. Higher average costs and
. Mark-up
Monopolistic Vs Perfect Competition: higher average cost.
Firms product at higher average cost in monopolistic Competition in the long run.
In monopolistic Competition, output is less than the efficient scale of Perfect Competition.
Monopolistic Vs Perfect Competition: markup over MC.
. For a competitive firm, P = MC
. For a monopolistically competitive firm, P > MC
. This means an extra unit sold at the posted price means more profit for the monopolistically competitive firm.
Markup is between MR MC intersection and P.
Monopolistic Competition and the welfare of society.
Monopolistic completion does not have the desirable properties of Perfect Competition:
. Mark-up of price over MC causes deadweight loss (like seen in monopolies)
. Regulating pricing of these firms is administratively prohibitive (costs of regulating firms with differentiated products exceeds the benefits)
. Socially inefficient (no. Of firms in the market may not be the ‘ideal’ one. There may be too much or too little entry)
. Externalities of entry
Externalities of entry.
Product-variety externalities: because consumers get some consumer surplus from the introduction of a new product, entry of a new firm conveys a positive externality on consumers.
Business-stealing externalities: because other firms lose customers and profits from the entry of a new competitor, entry of a new firm imposes a negative externality on existing firms.
Advertising and brand names.
The product differentiation inherent in monopolistic competition leads to the use of advertising and brand names.
Critics of advertising and brand names argue that firms use them to take advantage of consumer irrationality and to reduce competition.
Defenders of advertising and brand names argue that firms use them to inform consumers and to compete more vigorously on price and product quality.
