Monopolistic competition

thumb|300px|Short-run equilibrium of the company under monopolistic competition. The company maximises its profits and produces a quantity where the company's marginal revenue (MR) is equal to its marginal cost (MC). The company is able to collect a price based on the average revenue (AR) curve. The difference between the company's average revenue and average cost, multiplied by the quantity sold (Qs), gives the total profit. A short-run monopolistic competition equilibrium graph has the same properties of a monopoly equilibrium graph.

thumb|300px|Long-run equilibrium of the company assuming monopolistic competition. The company still produces where marginal cost and marginal revenue are equal; however, the demand curve (MR and AR) has shifted as other companies entered the market and increased competition. The company no longer sells its goods above average cost and can no longer claim an economic profit.

Monopolistic competition is a type of imperfect competition such that there are many producers competing against each other but selling products that are differentiated from one another (e.g., branding, quality) and hence not perfect substitutes. For monopolistic competition, a company takes the prices charged by its rivals as given and ignores the effect of its own prices on the prices of other companies. If this happens in the presence of a coercive government, monopolistic competition may evolve into government-granted monopoly. Unlike perfect competition, the company may maintain 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, cereals, clothing, shoes, and service industries in large cities. The earliest developer 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's book The Economics of Imperfect Competition presents a comparable theme of distinguishing perfect from imperfect competition. Further work on monopolistic competition was performed by Dixit and Stiglitz who created the Dixit-Stiglitz model which has proved applicable used in the subtopics of international trade theory, macroeconomics and economic geography.

Monopolistically competitive markets have the following characteristics:

There are many producers and many consumers in the market, and no business has total control over the market price.
Consumers perceive that there are non-price differences among the competitors' products.
Companies operate with the knowledge that their actions will not affect other companies' actions.
There are few barriers to entry and exit.
Producers have a degree of control of price.
The principal goal of the company is to maximize its profits.
Factor prices and technology are given.
A company is assumed to behave as if it knew its demand and cost curves with certainty.
The decision regarding price and output of any company does not affect the behaviour of other companies in a group, i.e., effect of the decision made by a single company is spread sufficiently evenly across the entire group. Thus, there is no conscious rivalry among the companies.
Each company earns only normal profit in the long run.
Each company spends substantial amount on advertisement. The publicity and advertisement costs are known as selling costs.

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 company 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, meaning that in the long run, a monopolistically competitive company will make zero economic profit. This illustrates the amount of influence the company has over the market; because of brand loyalty, it can raise its prices without losing all of its customers. This means that an individual company's demand curve is downward sloping, in contrast to perfect competition, which has a perfectly elastic demand schedule.

Characteristics

There are eight characteristics of monopolistic competition (MC):

Companies are price setters.
Free movement of resources from one company to another.
Product differentiation.
Many companies.
Freedom of entry and exit.
Independent decision making.
Some degree of market power.
Buyers and sellers do not have perfect information.

Product differentiation

MC companies sell products that have real or perceived non-price differences. Examples of these differences could include physical aspects of the product, location from which it sells the product or intangible aspects of the product, among others. However, the differences are not so great as to eliminate other goods as substitutes. In technical terms, the cross price elasticity of demand between goods in such a market is large and positive. MC goods are best described as close but imperfect substitutes. The fact that there are "many companies" means that each company has a small market share. This gives each MC company the freedom to set prices without engaging in strategic decision making regarding the prices of other companies (no mutual dependence) and each company's actions effect the market negligibly. For example, a company could reduce prices and increase sales without fear that its actions will prompt retaliatory responses from competitors.

The number of companies that an MC market structure will support at market equilibrium depends on factors such as fixed costs, economies of scale, and the degree of product differentiation. For example, the greater the fixed costs, the fewer companies the market will support.

Freedom of entry and exit

Like perfect competition, with monopolistic competition also, the companies can enter or exit freely. The companies will enter when the existing companies are making super-normal profits. With the entry of new companies, the supply would increase which would reduce the price and hence the existing companies will be left only with normal profits. Similarly, if the existing companies are sustaining losses, some of the marginal companies will quit. It will reduce the supply due to which price would rise and the existing companies will be left only with normal profit.

Independent decision-making

Each MC company independently sets the terms of exchange for its product. The company gives no consideration to what effect its decision may have on its competitors. Market power also means that an MC company faces a downward sloping demand curve. In the long run, the demand curve is very elastic, meaning that it is sensitive to price changes, although it is not completely "flat". In the short run, economic profit is positive, but it approaches zero in the long run.

Imperfect information

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

{| class="wikitable"

|+ Market structure comparison

! Market Structure

! Number of firms

! Market power

! Elasticity of demand

! Product differentiation

! Excess profits

! Efficiency

! Profit maximization condition

! Pricing power

| Perfect competition

| Infinite

| None

| Perfectly elastic

| None

| Short term yes, long term no

| Yes

| P=MR=MC

| Price taker

| High

| Short term yes, long term no

| No

| MR=MC

Socially undesirable aspects compared to perfect competition

Selling costs: Producers under monopolistic competition often spend substantial amounts on advertising and publicity. Much of this expenditure is wasteful from the social point of view. The producer can reduce the price of the product instead of spending on publicity.
Excess capacity: Under imperfect competition, the installed capacity of every firm is large but not fully used. Total output is, therefore, less than the output which is socially desirable. Since production capacity is not fully used, the resources lie idle. Therefore, the production under monopolistic competition is below the full capacity level.
Unemployment: Idle capacity under monopolistic competition expenditure leads to unemployment. In particular, unemployment of workers leads to poverty and misery in the society. If idle capacity is fully used, the problem of unemployment can be solved to some extent.
Cross transport: Under monopolistic competition expenditure is incurred on cross transportation. If the goods are sold locally, wasteful expenditure on cross transport could be avoided.
Lack of specialization: Under monopolistic competition, there is little scope for specialization or standardisation. Product differentiation practised under this competition leads to wasteful expenditure. It is argued that instead of producing too many similar products, only a few standardised products may be produced. This would ensure better allocation of resources and would promote the economic success of the society.
Inefficiency: Under perfect competition, an inefficient company is thrown out of the industry. But under monopolistic competition, inefficient companies continue to survive.

Problems

Monopolistically-competitive companies are inefficient, it is usually the case that the costs of regulating prices for products sold in monopolistic competition exceed the benefits of such regulation. A monopolistically-competitive company might be said to be marginally inefficient because the company produces at an output where average total cost is not a minimum. A monopolistically competitive market is a productively inefficient market structure because firms do not produce at the minimum of their average total cost (ATC) curve. Monopolistically-competitive markets are also allocative-inefficient, as the company charges prices that exceed marginal cost. Product differentiation increases total utility by better meeting people's wants than homogenous products in a perfectly competitive market.

Examples

In many markets, such as toothpaste, soap, air conditioning, smartphones, food and toilet paper, producers practice product differentiation by altering the physical composition of products, using special packaging, or simply claiming to have superior products based on brand images or advertising.

Notes

External links

Monopolistic Competition by Elmer G. Wiens

ja:寡占#寡占の分析