Showing posts with label Discuss the behavior of the firm under monopolistic competition. Show all posts
Showing posts with label Discuss the behavior of the firm under monopolistic competition. Show all posts

Monday, June 21, 2021

#5 GM 04 What is meant by monopolistic competition? Is product differentiation an outcome of monopolistic competition or vice-versa? Discuss the behavior of the firm under monopolistic competition.GM 04 Managerial economics AIMA PGDM assignment solution

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GM 05 Managerial economics AIMA PGDM assignment 

5. What is meant by monopolistic competition? Is product differentiation an outcome of       monopolistic competition or vice-versa?  Discuss the behavior of thefirm under monopolistic competition.

Monopolistic competition is a market situation in which there are many sellers of a particular product but the product of each seller is in some way differentiated in the minds of consumers from the product of every other seller.

Featuresof a Monopolistic Competition

  1. In Monopolistic Competition, a buyer can get a specific type of product only from one producer. In other words, there is product differentiation.
  2. The firms have to incur selling expenses since there is product differentiation.
  3. There is a large number of sellers with inter-dependent demand and supply conditions. Sellers are price-makers and the demand curve for the product of an individual seller is downward sloping. The demand is not perfectly elastic.
  4. The firm can improve or deteriorate the quality of its products too. Improving the quality helps in increasing the demand and price of the product. On the other hand, deteriorating the quality helps reduce the average cost of production.
  5.  The firms compete for inputs too. Also, they need to operate within a given technological range. Therefore, no firm can produce a better quality product at a lower average cost.
  6. Firms are expected to know its demand and cost conditions. Further, they must use this knowledge to maximize its expected profit income.
  7. Any firm can leave the group of firms belonging to a specific product group. Also, new firms can enter the group and produce close substitutes of the existing products in the group. This ensures that no firm incurs losses or earns super-normal profits.
  8. In Monopolistic Competition, every firm must pursue the goal of profit maximization.
  9. It is assumed that all firms in this market structure have identical cost and demand conditions.

Monopolistic competition and Productdifferentiation

Yes, Product differentiation is an outcome of monopolistic competition or vice-versa as monopolistic competition is the market structure which combines typical features of monopoly and perfect competition. Similar to perfect competition there are many small firms in the market. Their decisions are assumed to be not interdependent. There is free entry of firms to the market with monopolistic competition. But due to product differentiation each firm behaves like a monopolist at its narrow segment of an aggregate market of close substitutes. Each firm has market power to influence the price for its product choosing the volume of output. The distinguishing feature of monopolistic competition which makes it as a blending of competition and monopoly is the differentiation of the product. This means that the products of various firms are not homogeneous but differentiated though they are closely related to each other. Product differentiation does not mean that the products of various firms are altogether different.

They are only slightly different so that they are quite similar and serve as close substitutes of each other. When there is any degree of differentiation of products, monopoly element enters the situation. And. the greater the differentiation, the greater the element of monopoly involved in the market situation.

When there are a large number of firms producing differentiated products, each one has a monopoly of its own product but is subject to the competition of close substitutes. Since each is a monopolist and yet has competitors, there is a market situation which can be aptly described as “monopolistic competition.”

With differentiation appears monopoly and as it proceeds further, the element of monopoly becomes greater. Where there is any degree of differentiation whatever, each seller has an absolute monopoly of his own product, but is subject to the competition of more or less imperfect substitutes. Since each is a monopolist and yet has competitors we may speak of them as ‘competing monopolists’ and with peculiar appropriateness, of the forces at work as those of monopolistic competition.”

Many examples of product differentiation can be taken from market such as there are various manufacturers of toothpaste which produce different brands such as Colgate. Patanjali Dant kanti, Binaca, Forhans, Pepsodent, Signals, Neem etc. Thus, the manufacturer of ‘Colgate’ has a monopoly of producing it (nobody else can produce and sell the toothpaste with the name ‘Colgate’) but it faces competition from the manufacturers of Patanjali, Forhans, Binaca, Pepsodent etc. which are close substi­tutes of Colgate. A general class of product is differentiated if a basis exists for preferring goods of one seller to those of others. Such a basis for preference may be real or fancied; it will cause differentiation of the product. When such differentiation of the product exists, even if it is slight, buyers will be paired with sellers not in a random fashion (as in perfect competition) but according to their preferences.

Monopolistic competition corresponds more to the real world economic situation than perfect competition or monopoly and product differentiation pops out to keep market monopolistic as well as competitive. Thus, it can be said that product differentiation an outcome of       monopolistic competition or vice-versa.

 Behavior of the firm under monopolisticcompetition

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.

Unlike in perfect competition, firms that are monopolistically competitive maintain spare capacity. Models of monopolistic competition are often used to model industries. 

Firm’s behaviour in short run underMonopolistic competition

Like monopolies, the suppliers in monopolistic competitive markets are price makers and will behave similarly in the short-run. Also like a monopoly, a monopolistic competitive firm will maximize its profits by producing goods to the point where its marginal revenues equals its marginal costs. The profit maximizing price of the good will be determined based on where the profit-maximizing quantity amount falls on the average revenue curve. The profit the firm makes is the amount of the good produced multiplied by the difference between the price minus the average cost of producing the good.

Since monopolistically competitive firms have market power, they will produce less and charge more than a firm would under perfect competition. This causes deadweight loss for society, but, from the producer’s point of view, is desirable because it allows them to earn a profit and increase their producer surplus. Because of the possibility of large profits in the short-run and relatively low barriers of entry in comparison to perfect markets, markets with monopolistic competition are very attractive to future entrants.

 Short Run Equilibrium under Monopolistic Competition:

As seen from the chart, the firm will produce the quantity (Qs) where the marginal cost (MC) curve intersects with the marginal revenue (MR) curve. The price is set based on where the Qs falls on the average revenue (AR) curve. The profit the firm makes in the short term is represented by the grey rectangle, or the quantity produced multiplied by the difference between the price and the average cost of producing the good.



 

 

Firm’s behaviour in long run under Monopolistic competition

Like monopolies, the suppliers in monopolistic competitive markets are price makers and will behave similarly in the long-run. Also like a monopoly, a monopolistic competitive firm will maximize its profits by producing goods to the point where its marginal revenues equals its marginal costs. The profit maximizing price of the good will be determined based on where the profit-maximizing quantity amount falls on the average revenue curve.

 

While a monopolistic competitive firm can make a profit in the short-run, the effect of its monopoly-like pricing will cause a decrease in demand in the long-run. This increases the need for firms to differentiate their products, leading to an increase in average total cost. The decrease in demand and increase in cost causes the long run average cost curve to become tangent to the demand curve at the good’s profit maximizing price. This means two things. First, that the firms in a monopolistic competitive market produce a surplus in the long run. Second, the firm is only able to break even in the long-run; it will not be able to earn an economic profit.

Long Run Equilibrium of Monopolistic Competition:

In the long run, firms in a monopolistic competitive market will produce the amount of goods where the long run marginal cost (LRMC) curve intersects marginal revenue (MR). The price is set where the quantity produced falls on the average revenue (AR) curve. The result is that in the long-term the firm will break even.