Questions
1. List the characteristics of monopolistic
competition?
2. With the help of a diagram explain the
short-run equilibrium of a monopolistically
competitive market structure.
MONOPOLISTIC COMPETITION
We have examined the two
extreme market forms – namely
‘perfect competition’ and
‘monopoly’.
While the ‘commodity’ market for
potatoes is a real-life example of
the former, and Indian Railways of
the latter, in actual practice both
these market forms are rare.
In the real world, the dominating market
structure is ‘imperfect competition’.
The maim form of imperfect competition is
‘monopolistic competition’.
Monopolistic Competition is a market form in
which there are a large number of sellers
Of a particular product but each seller markets
a differentiated product.
Features of Monopolistic Competition
Many buyers and sellers. There
are a large number of sellers,
each catering to a small (not
microscopic) share of the market
demand for a similar but not
identical product. There are also a
large number of buyers for this
differentiated product.
Differentiated Product – Each seller’s product
has some features that distinguish it from the
products of its competitors. i.e. the competing
products are not perfect substitutes, though
they serve the same general purpose for the
consumers.
E.g. there are many brands of bath soap –
Lux, Margo, Dove, Cinthol etc – all aimed at
body cleanliness – but each projecting
different qualities.
No consideration of the reactions of
rivals. The firms in the market do not
consider the reactions of their rivals
while choosing their prices or targets.
Relative freedom of entry and exit - there
are no major hurdles like long gestation
period, huge investments, complicated
licensing procedures and the like for
entering the market or exiting it.
No incentive to decrease the competition
– Neither the opportunity nor the
incentive exists for the firms in the
market to cooperate in ways that
decreases competition.
Product differentiation – usually
enhanced through advertising - rather
than pricing, is the is the basis of
competition.
Profit maximization is the only goal of the
firm – Each firm seeking to optimize
earnings will manufacture at the priceoutput combination resulting in the
equality of marginal cost to marginal
revenue.
In the short-run, super-normal profits will
be earned. However, in the long-run,
super-normal profits will be reduced to
normal profits because of the entry of
new firms into the market.
MONOPOLISTIC COMPETITION SHORT RUN EQUILIBRIUM
EARNING SUPER-NORMAL PROFIT
Short-run equilibrium of the firm under
monopolistic competition. The firm maximizes
its profits and produces a quantity where the
firm's marginal revenue (MR) is equal to its
marginal cost (MC). The firm is able to collect
a price based on the average revenue (AR)
curve. The difference between the firm’s
average revenue and average cost gives it a
profit.
Positive profit in the short-run will attract new
firms, which will be easy as there are no entry
barriers. Consequently, total demand will get
distributed among all the greater number of
competing firms each marketing a differentiated
product
Demand for the individual firm will decrease
causing a leftward parallel shift in their respective
AR curves. Entry of new firms will continue until
super-normal profits disappear. Also, loss-making
firms will exit, causing a rightward parallel shift in
the AR curves of the remaining firms.
This process of shift in the AR curve (either
left-ward or rightward) will continue until the
firms arrive at a no-loss, no-profit situation.
In other words the AR curve will keep
shifting until it becomes tangential to the
AC curve. This is th long-run equilibrium
situation.
MONOPOLISTIC COMPETITION LONG RUN EQUILIBRIUM
Long-run equilibrium of the firm under
monopolistic competition. The firm still produces
where marginal cost and marginal revenue are
equal; however, the demand curve (and AR) has
shifted as other firms entered the market and
increased competition. The firm no longer sells
its goods above average cost and can no longer
claim an economic profit
NUMERICAL
Appetite, a small restaurant in Kolkata, is
known for both Chinese and Tibetan cuisine.
charges Rs 50/- for a plate of fried chicken
momo, the demand curve for which is
estimated as Q1= 200 - 0.50P. With
increasing his sales in view, the owner of
Appetite launches an advertisement
campaign which is received well.
It
1.What possible changes in demand curve
can be expected after the launch of this
effective advertising campaign.
2.If the post-ad demand curve for fried
chicken momo becomes Q2 = 250 - 0.10P,
how many extra plates will sell, assuming
that the price is not changed.
SOLUTION
Since it is mentioned that the advertising
campaign is effective, it will cause an upward
shift in the demand curve implying increase
in the vertical intercept of the demand curve.
Besides, it is logical to expect that a
successful advertising campaign helps in
building customer loyalty.
In that case it will not be unjust to anticipate
a steeper demand curve implying reduced
price elasticity of demand, cetirus paribus.
Sales of momo can be calculated as
Post-ad :
Q2 = 250 - 0.10P
= 250 - 0.10(50) = 245
Pre-ad :
Q1 = 200 - 0.50P
= 200 - 0.50(50) = 175
Extra plates = Q2 - Q1 = 245 – 175 = 70