MonopolisticCompetitionGCE A-LEVEL& IBECONOMICS

WhatisMonopolisticCompetition?

Thinkofa‘reallifeversion’ofperfectcompetition

- Perfect Imperfect Information

- Unlimited Large numberofbuyers(consumers)andsellers(firms)

- Homogeneous(Same)Goods Differentiated Goods

- Pricetakingfirms(butcansettheirownprices,nottheindustry)

- No Low barrierstoentryorexit

- Branding,advertisingandproductdevelopmentisimportant

MarketStructures&Competition

More competitive

Less competitive

Perfectcompetition

Monopolisticcompetition

Oligopoly

Monopoly

MarketsinMonopolisticCompetition

TuitionLessons PizzaShops ChineseRestaurants

RevenuesUnderMonopolisticCompetition

Undermonopolisticcompetition,therearemoresubstitutesthaninamonopolybutlesssubstitutesthaninperfectcompetitionduetoproductdifferentiation.Therefore,thedemandcurveismoreelasticthanthatofamonopolybutlesselasticthanperfectcompetition.

D=AR

Output0

Price/Revenue

MR

RevenuesUnderMonopolisticCompetition

Firmshavesomedegreeofmonopolypower,cansettheirownpricesandhencethedemandwillbedownwardsloping.Morewillbeboughtandproducedwhenpricechargedperunitislow,andviceversa.

D=AR

Output0

Price/Revenue

MR

MonopolisticCompetitionShortRunDiagram

Intheshortrun,themonopolisticcompetitiondiagramwillbesimilartothemonopolydiagram.

FirmscanmaximizeprofitsattheoutputofMC=MR.Whichassumptionallowsthemtodothis?

ARMR

Price

OutputQ10

MC

AC

ARMR

C1

P1

MonopolisticCompetitionShortRunDiagram

Byhavingdifferentiatedgoods,theywillbeabletoactlikeamonopolytosomedegreeandmakeabnormalprofitsintheshortrun.

ARMR

Price

OutputQ10

MC

AC

ARMR

C1

P1

MonopolisticCompetitionShortRunDiagram

Whatdoyouthinkwillhappentoprofitsinthelongrun?

Whatabouttheelasticityofdemand/revenueandcosts?

ARMR

Price

OutputQ10

MC

AC

ARMR

C1

P1

MonopolisticCompetitionLongRunDiagram

Inthelongrunwhereallfactorsofproductionarevariable(nofixedfactors),newfirmswillbeabletoenterthemarket(lowbarriers).

Hence,therewillbemoresubstitutesanddemand(averagerevenue)willbemoreelastic.Averagecostsarealsolikelytobehigherasfirmsproducealoweramountofoutputduetohighercompetitionintheindustry. AR

MR

Price

Output0

MC

AC

MonopolisticCompetitionLongRunDiagram

ARMR

Price

Output0

MC

AC

Asaresultofthedemandandcostchanges,firmswillonlyearnnormalprofitsinthelongrun.Theabnormalprofitsintheshortrunwillbecompetedawaygiventheincreaseinindustrysupply.

NotethatduetotheincreaseinthePED,theACcurvewillbetangenttotheARatthepointwherethefirmsmaximizeprofits.

P1=C1

EvaluatingMonopolisticCompetition

Towhatextentdoesmonopolisticcompetitionbenefitconsumers?

- Differentiatedgoodsallowforchoiceofconsumers

- Productdifferentiationrequiresaneedforproductdevelopment,andfirmsinthemarketcanafforditwithshorttermsupernormalprofits

- Effectdependsonthesize/numberoffirmsandrateofproductdifferentiation

EvaluatingMonopolisticCompetition

Howmuchdoesthetheoryapplyinreallife?

- Notasextremeastheperfectcompetitionmodelandrelatabletoreallife

- Somethingstothinkabout:◦ Howlongisthelong run?Consumer tastesareever-changingandnewsubstitutesmaynotenterthemarketfastenough.

◦ Willfirmscontinuetocompetebyproductdifferentiationwhenmoresubstitutesareavailable?Howwillthemarketchange?

ShortQuestions- MonopolisticComp.

- Suggest2assumptionsundermonopolisticcompetition?

- Whyisthemonopolisticcompetitionintheshort-runsimilartothatofamonopoly?

- Howwillprofitsofthemonopolisticfirminthelongrunchange?Why?

- Thinkof1advantageand1disadvantageunderthemonopolisticcompetitionstructure.