Monopolistic Competition

Thomas Sim PEA2066

Q.
a) Discuss the characteristics of the following market structure. Support your answer with examples.

i) Perfect competition. (5 marks)

ii) Monopolistic competition. (5 marks)

(5 marks, 2012 Q4aii)

A.
Monopolistic competition is a type of imperfect competition such that many producers sell products that aredifferentiated from one another (e.g. by branding or quality) and hence are not perfect substitutes. 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.[1][2] 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).[3] Joan Robinson published a book The Economics of Imperfect Competition with a comparable theme of distinguishing perfect from imperfect competition.

Monopolistically competitive markets have the following characteristics:

  1. There are many producers and many consumers in the market, and no business has total control over the market price.
  2. Consumers perceive that there are non-price differences among the competitors' products.
  3. There are few barriers to entry and exit.[4]
  4. Producers have a degree of control over price.

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.

Examples of monopolistic competitions are:
In many markets, such as toothpastes and toilet paper, producers practice product differentiation by altering the physical composition of products, using specialpackaging, or simply claiming to have superior products based on brand images or advertising.

Ref:

Wikipedia search 'monopolistic competition' at
http://en.wikipedia.org/wiki/Monopolistic_competition