Monopolistic Competition and its Characteristics

Monopolistic competition is a type of imperfect competition such that many producers sell products that are differentiated from one another as goods but not perfect substitutes (such as from branding, quality, or location). In monopolistic competition, a firm takes the prices charged by its rivals as given and ignores the impact of its own prices on the prices of other firms. In the presence of coercive government, monopolistic competition will fall into government-granted monopoly. Unlike perfect competition, the firm maintains spare capacity. Models of monopolistic competition are often used to model industries. Textbook examples of industries with market structures similar to monopolistic competition include restaurants, cereal, clothing, shoes, and service industries in large cities. The "founding father" of the theory of monopolistic competition is Edward Hastings Chamberlin, who wrote a pioneering book on the subject, Theory of Monopolistic Competition (1933). Joan Robinson published a book The Economics of Imperfect Competition with a comparable theme of distinguishing perfect from imperfect competition.

The long-run characteristics of a monopolistically competitive market are almost the same as a perfectly competitive market. Two differences between the two are that monopolistic competition produces heterogeneous products and that monopolistic competition involves a great deal of non-price competition, which is based on subtle product differentiation. A firm making profits in the short run will nonetheless only break even in the long run because demand will decrease and average total cost will increase. This means in the long run, a monopolistically competitive firm will make zero economic profit. This illustrates the amount of influence the firm has over the market; because of brand loyalty, it can raise its prices without losing all of its customers. This means that an individual firm's demand curve is downward sloping, in contrast to perfect competition, which has a perfectly elastic demand schedule.

There are six characteristics of monopolistic competition (MC):

1. Product differentiation

MC firms sell products that have real or perceived non-price differences. However, the differences are not so great as to eliminate other goods as substitutes. Technically, the cross price elasticity of demand between goods in such a market is positive. In fact, the XED would be high. MC goods are best described as close but imperfect substitutes. The goods perform the same basic functions but have differences in qualities such as type, style, quality, reputation, appearance, and location that tend to distinguish them from each other. For example, the basic function of motor vehicles is basically the same—to move people and objects from point A to B in reasonable comfort and safety. Yet there are many different types of motor vehicles such as motor scooters, motor cycles, trucks, cars and SUVs and many variations even within these categories.

2. Many firms

There are many firms in each MC product group and many firms on the side lines prepared to enter the market. A product group is a "collection of similar products". The fact that there are "many firms" gives each MC firm the freedom to set prices without engaging in strategic decision making regarding the prices of other firms and each firm's actions have a negligible impact on the market. For example, a firm could cut prices and increase sales without fear that its actions will prompt retaliatory responses from competitors. How many firms will an MC market structure support at market equilibrium? The answer depends on factors such as fixed costs, economies of scale and the degree of product differentiation. For example, the higher the fixed costs, the fewer firms the market will support. Also the greater the degree of product differentiation—the more the firm can separate itself from the pack—the fewer firms there will be at market equilibrium

3. Free entry and exit in the long run

In the long run there is free entry and exit. There are numerous firms waiting to enter the market each with its own "unique" product or in pursuit of positive profits and any firm unable to cover its costs can leave the market without incurring liquidation costs. This assumption implies that there are low start up costs, no sunk costs and no exit costs. The cost of entering and exit is

4. Independent decision making

Each MC firm independently sets the terms of exchange for its product. The firm gives no consideration to what effect its decision may have on competitors. The theory is that any action will have such a negligible effect on the overall market demand that an MC firm can act without fear of prompting heightened competition. In other words each firm feels free to set prices as if it were a monopoly rather than an oligopoly.

5. Some degree of market power

MC firms have some degree of market power. Market power means that the firm has control over the terms and conditions of exchange. An MC firm can raise its prices without losing all its customers. The firm can also lower prices without triggering a potentially ruinous price war with competitors. The source of an MC firm's market power is not barriers to entry since they are low. Rather, an MC firm has market power because it has relatively few competitors, those competitors do not engage in strategic decision making and the firms sells differentiated product. Market power also means that an MC firm faces a downward sloping demand curve. The demand curve is highly elastic although not "flat".

6. Buyers and Sellers do not have perfect information (Imperfect Information)

No sellers or buyers have complete market information, like market demand or market supply

40. Types of economic systems and patterns of economic transition

Traditional systems. In some underdeveloped countries are traditional, based on customs economic systems. Traditions passed down from generation to generation, determine what products and services, how and for whom to produce. The list of goods of the technology of production and distribution are based on customs. Economic roles of individuals are determined by heredity and caste. Technical progress is enters in these systems with difficulty, as it is in conflict with tradition and threatens the stability of the regime.

Command economy. All decisions on basic economic issues is making by government. All of the resources here are the property of the government. Centralized economic planning covers all levels - from the household to the state. The allocation of resources is based on the long-term priorities.

Planned economy – is a system where state property is a dominant form, economic decisions are adopted collectively and economy is ruled by central planning.

Market economy – is a system, based on private property, freedom of choice and competition, personal interests and limited government interference. In a market economy, all the answers to the basic economic questions: What? how? and for whom? - Define the market, prices, profits and losses.

Mixed economy – is a system which combines elements of market and planned economy and market mechanism is supported by “active” state.

41. Elasticity of Demand

The degree to which demand for a good or service varies with its price. Normally, sales increase with drop in prices and decrease with rise in prices. As a general rule, appliances, cars, confectionary and other non-essentials show elasticity of demand whereas most necessities (food, medicine, basic clothing) show inelasticity of demand (do not sell significantly more or less with changes in price).

Also called price demand elasticity.

The Price Elasticity of Demand (commonly known as just price elasticity) measures the rate of response of quantity demanded due to a price change. The formula for the Price Elasticity of Demand (PEoD) is:

PEoD = (% Change in Quantity Demanded)/(% Change in Price)

42. Economic growth as a goal of social reproduction

Economic growth is the increase in the market value of the goods and services produced by an economy over time. It is conventionally measured as the percent rate of increase in real gross domestic product, or real GDP

Date: 2016-01-03; view: 1219