8/13/2019 Monopolistic Competition Easy Notes

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IB Economics notesMonopolistic competition

Neil.elrick@tes.tp.edu.tw

Monopolistic Competition

It is wrong to assume that competition is good and monopoly power is bad. The reality is much morecomplex than this as we shall see when we analyse and evaluate imperfectly competitive marketswhere existing firms have genuine market power in setting prices for consumers.However there does appear to be a consensus that increasing the amount of competition in a market can

bring about positive side-effects not only for consumers but also for society as a whole. In this section weconsider briefly some of the effects of competition within a market and we return to it when we considerthe nature and consequences of contestable markets.

Adam Smith on Competition

The natural price or the price of free competition ... is the lowest which can be taken. [It] is the lowestwhich the sellers can commonly afford to take, and at the same time continue their business.

Adam Smith, the Wealth of Nations (1776), Book I, Note VII

The common characteristics of markets that are considered to be competitive are:

Lower prices because of the large number of competing firms. Suppliers face elastic demandcurves and any rise in price will lead to a fall in demand and in total revenue. The cross-priceelasticity of demand for one product with respect to a change in the price of another will be highsuggesting that consumers are prepared to switch their demand to the most competitively pricedproducts in the market-place.

Low barriers to entry new firms will find it relatively easy to enter markets if they feel there isabnormal profit to be made. The entry of new firms provides competition and ensures prices arekept low in the long run.

Lower total profitsand lower profit margins than in markets which dominated by a few firms. Greater entrepreneurial activity the Austrian school of economics argues that true

competition is a process rather than a static condition. For competition to be improved andsustained there needs to be a genuine desire on behalf of entrepreneurs to engage in competitivebehaviour, to innovate and to invent to drive markets forward and create what Joseph Schumpeterfamously called the gales of creative destruction.

Economic efficiency competition will ensure that firms attempt to minimise their costs andmove towards productive efficiency. The threat of competition should lead to a faster rate oftechnological diffusion, as firms have to be particularly responsive to the changing needs ofconsumers. This is known as dynamic efficiency.

The UK government has a firm commitment to competition as part of its competition policy agenda. In adetailed research document on the static and dynamic gains from increasing the contestability of UKmarkets publishes in 2004, the Department for Trade and Industry came out firmly in favour of a pro-competition policy regime. This short quote provides a flavour of their arguments.

The gains from greater competitionCompetition is a process, in which the long-run and short-run may look very different, and in which firmsuse a variety of weapons not just price with which to compete. Innovation, product design and varietyare often important parts of the competitive game between firms

Source: DTI report on competition in UK markets, July 2004

The importance of non-price competitionIn competitive markets which are not perfectly competitive, frequently it is the effectiveness of non-pricecompetition which is crucial in winning sales and protecting or enhancing market share.

Panini Peddlers, Baps, Baguettes and Bagels - Product Differentiation in the Sandwich MarketAccording to the British sandwich industry, approximately 1.8 billion sandwiches are purchased outside thehome each year and the retail sandwich market is worth approximately 3.5 billion, over three times the

8/13/2019 Monopolistic Competition Easy Notes

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IB Economics notesMonopolistic competition

Neil.elrick@tes.tp.edu.tw

value of the pizza market for example. About a million consumers buy sandwiches five days a week. Theindustry employs over 300,000 people and if the latest consumer profiles are to be believed, the most likelyperson in front of you in the queue for a bap, wrap or baguette is likely to be male, between 25-44 yearsold and also in a rush our average lunch break is now less than thirty minutes! From our largestsupermarkets to the smallest corner shop; from dedicated sandwich makers who deliver direct to offices tocoffee shops and independent sandwich bars, from petrol stations to pubs and local and national chains ofbakers, the many competing suppliers in the industry are fighting a daily battle for sales, revenue and

market share.

Differentiating the productHere are some of the ways in which the humble sandwich can be made distinct against its competitors inthe market-place:

Hot and cold sandwiches Different styles e.g. a bap, baguette, wraps and filled bagels Speciality breads such as focaccia and ciabatta Product range - including Organic ingredients Healthy options (e.g. non-mayo) Packaging and branding Quality of ingredients Different fillings Made to order in the store / off the shelf / home or work delivery of sandwiches Finest range / value sandwiches

Price matters in the market but not perhaps to the degree that people expect. According to research fromfood analysts Winship, UK sandwich consumers are not always driven by price and they are moreconcerned with perceived value for money and will pay more for a product they believe delivers that ratherthan shop around for cheaper offerings.