Monopolistic Competition By: Dan Kreitl Monopolistic competition is the middle ground between perfect competition and monopoly. A perfectly competitive firm sells a product identical to its competition and the firm is thus a price taker. A monopoly firm sells a product with no competition, and is therefore a price-setter. However, there is a lot of middle ground between the two markets, monopolistic competition, which will be shared in this paper.
- Monopoly: A monopoly is a situation in which a singlecompanyowns all or nearly all of the market for a given type of product or service. This would happen in the case that there is a barrier to entry into the industry that allows the single company to operate without competition (for example, vast economies of scale, barriers to entry, or governmental regulation). In such an industry structure, the producer will often produce a volume that is less than the amount which would maximize social welfare. (Investorwords.com) An example of a monopoly would be if Comcast was the only cable provider in an area. All residents in the area who would like cable television would be required to use the services of Comcast and would be subject to whatever price they would charge.
- Perfect Competition: "Perfect competition is one in which no participant can influence prices. The market is characterized by a free flow of information, no barriers to entry, and a large number of buyers and sellers.” (Investorwords.com) Perfect competition is “an economic model that describes a hypothetical market form in which no producer or consumer has the market power to influence prices. While monopolistic competition is inefficient, perfect competition is the most efficient, with supply meeting demand and production therefore matching this, so stock is not sat in storage for prolonged periods or going to waste.” (Market Competition Perfect and Monopolistic Competition) A close-to-home example in Indiana of nearly perfect competition would be agricultural commodities, such as corn and beans. The products are very similar between producers and the farmers have little to no influence on price because of the lack of market power in a nearly perfectly competitive market.
- Monopolistic Competition: “Monopolistic competition is a market structure in which several or many sellers each produce similar, but slightly differentiated products. Each producer can set its price and quantity without affecting the marketplace as a whole.” (Investorwords.com) An example of monopolistic competition, often eaten for breakfast, is cereal. There are many different kinds of cereal for a buyer to choose from. Often times buyers will have a preference for a certain cereal, say Captain Crunch, and are willing to pay a bit more if necessary to buy the kind and brand of cereal they prefer. However, cereal sellers must not exceed their buyer's maximum purchase price because buyers will at some price level purchase a different, but similar product in the monopolistically competitive market.
Characteristics of Monopolistic Competition:
Free Entry
Product Differentiation
Many Buyers and Sellers
Limited Pricing Power
Downward Sloping Demand Curve
1. Free Entry A monopolistically competitive industry has no barriers to entry, (Baye Pg. 293). Firms can come and go within the market without significant costs. A single firm earning economic profits will be joined by competition fairly quickly due to free entry. When firms in a monopolistically competitive market are making a profit, new firms have incentive to enter the market. - "As firms enter the market the number of products consumers can choose increases. As a result, the demand curve for each firm shifts to the left. The process of exit and entry continues until firms are earning zero profit. This means the demand curve and the average total cost curve are tangent to each other." (Monopolistic Competition- Lecture Notes) - There are also externalities associated with entry. The product variety externality occurs because as new firms enter, consumers get some consumer surplus from the introduction of new product. (Positive Externality) However as the business stealing externality occurs because as new firms enter the market, other firms lose customers and profit. (Negative Externality) Thus, depending on which externality is larger, a monopolistically competitive market could have too few or too many firms. (Monopolistic Competition- Lecture Notes)
2. Product Differentiation There are many firms that compete in a monopolistically competitive firm and the products are fairly similar. However, the competition is not directly head to head in that there is room within the market for firms to differentiation among products. Likewise, prices between markets will vary somewhat. “Firms have some scope to raise prices without losing all their customers as their products have some unique selling point that appeals to particular consumers.” (Applied Economics for Managers) - An example of a similar, but unique product is book sales. Within reason, book sellers and set their own price according to the uniqueness and popularity of the book. However, there is a point where the book seller does not offer enough product differentiation to raise prices beyond a certain price. Sellers work to set output level where marginal revenue is equal to marginal cost. “The price is set using the demand curve to ensure that consumers will buy the amount produced,” (Monopolistic Competition Lecture Notes). - 3. Many Buyers and Sellers A market in which there are many buyers and sellers means that firms must compete. Depending on how competitive a market is will determine to what degree a firm will have, or not have, pricing power. An example of a monopolistically competitive market which certainly has a large number of buyers and sellers is CD sales. With a large number of music producers and wide variety of individual music preferences, the CD market consists of many buyers and sellers. - 4. Limited Pricing Power Because a monopolistically competitive firm is able to offer a differentiated product, the firm will have a certain degree of pricing power. Whereby, a firm offering a product that is slightly unique from its competition will have some ability to charge a higher price without losing all its buyers. However, the market is competitive enough that buyers will find a different seller if prices exceed the maximum price they are willing to pay. As a result, firms in a monopolistically competitive market must find unique ways to differentiate its products so it has some market power. “Unlike in perfect competition, the monopolistic competitive firm does not produce at the lowest possible average total cost. Instead, the firm produces at an inefficient output level, reaping more in additional revenue than it incurs in additional cost versus the efficient output level.” (authorpalace.com).
- A classic example showing how businesses work to provide product differentiation is restaurants. Restaurants differentiate from one another through advertising, offering unique dining experiences, home delivery options, unique food offerings, and by how they package and brand the company name. It is through product differentiation that many restaurants have become successful, even though the product differentiation may be settle. Restaurants competing in a monopolistically competitive market set prices higher than marginal cost because the firm has some market power. However, it should be mentioned that the markup over marginal cost is a source of inefficiency which implies deadweight loss.
- 5. Downward Sloping Demand Curve Baye's shares in our textbook a major difference between a monopolistically competitive market and a market serviced by monopolist. A monopolistically competitive firm faces a downward sloping demand for its products because there are other firms in the industry that sell similar products. To maximize profits, a monopolistically competitive firm produces where its marginal revenue equals its marginal cost. The profit maximizing price is the maximum price per unit that consumers are willing to pay for the profit maximizing level of output. (Baye, pg. 294)
Questions (1-5) - 1:What direction does the demand curve travel of a monopolistically competitive market and explain why it travels that direction. Answer: A monopolistically competitive firm faces a downward sloping demand for its products because there are other firms in the industry that sell similar products. - 2:If a monopolistically competitive firm is earning zero economic profits what would be the relationship between price and average total cost? Answer: P = ATC When price is equal to average total cost, the firm is earning zero economic profit. - 3:A monopolistically competitive firm has a demand curve and ATC curve that is tangent to each other. Why is it that the demand curve does not cross the ATC curve? Answer: For the demand curve to cross the ATC curve it would mean that P > ATC at some output level. - 4:Is a monopolistically competitive market efficient or inefficient and explain why. Answer: Markets that are monopolistically competitive fall at some point between being efficient and inefficient. The markets are somewhat efficient because there are many firms selling similar products. However, the products differentiate from one another creating some level of market power, thus creating some level of inefficiency. A perfectly competitive market is efficient and a monopoly is inefficient, with monopolistic competition in the middle. - 5: With perfect competition price is equal to marginal cost, the efficient scale. What is the relationship between price and marginal cost for monopolistic competition and why? Answer: The relationship between price and marginal cost is that price is greater than marginal cost. This is because the firm has some market power. Firms in monopolistic competition have excess capacity because the firm could increase its output and lower its average total cost of production.
I enjoyed reading the wiki about profit and opportunity cost. It was a well writen review of profit and opportunity costs. The paper was written in a way that was easy to read.
So often with economics things seem so simple, but then when the subject is examined more closely it becomes a far more complex entity. For example, cost is a basic financial term. However, when you read about implicit costs, explicit costs, opportunity costs, and marginal cost the terms get more complex. I was glad wiki #14 explained the terms again for more clairty.
I must say since being in grad school I am regularly thinking about the opportunity cost of nearly every decision I make. It is nice to have ample real world situations to apply the concepts of economics to.
The questions in wiki #14 were interesting and informative as well.
Summary 2: Wiki # 5 (Green Company by James Casteel) I thought this was a very well written wiki. I also found the graphics to be eye catching and very informative. It was an interesting topic, so it was easy to stay focused through the reading. It is interesting to consider green technology, the improvements we’ve seen over the years, and to wonder what the future will bring. I am confident we will see continued development and advancement in green technologies and renewable energy as we continue into the future. Considering the fundamental business decisions Green Company faces, I thought James did a good job explaining the situation and potential solutions to the questions the company faced. The end of paper questions were interesting and of sufficient difficulty.
Summary 3: Wiki # 7 (Government Policy by Anthony Christofaro) I really enjoyed this article because the topic was of great interest. Anthony did a great job explaining the logic and history behind his claims. He had good explanations of the case and sources he referenced. It is interesting to consider the attempts of the government to regulate citizen actions and choices. Referencing the prohibition of alcohol, it is a large under taking to ban a widely enjoyed good. The economics of such regulation is also interesting. The cost of the government enforcing such a ban would be costly. However, the revenue generated though fines could potentially be a revenue generator for the government. I know I have heard talk of illegal possession of drugs to be reduced from an arrest, to a large fine. The thought behind this notion is that it takes police a lot of time and paper work to arrest and hold a violator of drugs. Therefore, the cost to the state is great. However, reducing the cost, and simply fining for the common violation could be a great revenue generator for the state government. It will be exciting to see how this plays out. Good Paper!
Summary 4: Wiki # 45 (Risk, Mean, Variance, Risk Aversion by Amy Urbanski) I thought Amy did a great job explaining the statistical terms in her paper. She gave a detailed description of the risk measurement tools used in statistical analysis. Her questions were very informative and also challenging. I enjoyed reading her report. I did think the paper could have been improved with more practical application and real world examples of the use of statistical analysis methods. As a student in stats class currently, I often wonder how, when, and in what fashion will I utilize the concepts and processes I am currently learning. For that reason, I enjoy reading and learning about how I may realistically use statistical analysis. However, I must admit that I have found the use of stats in my early business career to be much more evident and useful than I had ever expected during my undergrad years. With that thought, I wonder how much more I will use stats as I advance in business. Overall, a well written, organized, and informative paper.
Summary 5: Wiki # 43 (Pricing by Carter Sprunger) This was perhaps the best article I have read on the wiki’s. It was very well written and very thorough. Carter gave a very good description of the terms he used and great examples when applying the concepts to real world examples. It was interesting to read about the process of a producer determining the optimal price of their goods. The use of strategies such as markups, networks, penetration pricing, transfer pricing, limit pricing, and price matching were all insightful way in which producers work to profitably price their goods. As well the idea of raising rival costs and randomized pricing were interesting. I can’t help but wonder at what level of business are these concepts are these concepts identified and used by their economic name when pricing goods. My experience with small businesses is that while business owners naturally apply and consider these concepts, they may be oblivious to the economic concepts they are utilizing. However, I know that is a stereotype of small businesses. The questions at the end were well thought out and challenging. This was a well written and knowledgeable use of the wiki project.
End of five Wiki summaries
Blog Posts:
Entry Seven:
The following article does a great job explaining monopolistic competition. Enjoy the reading and I will be following up this week with further discussion of the article.
Long Run Equilibrium
In the long run, entry and exit are both possible. If profit is greater than zero, businesses will enter, and each company's market share will fall because of more variety. As a result, each company’s demand curve will decrease, along with price and quantity. If profit is less than zero, businesses will exit, and each company’s market share will increase. This will cause the remaining companies' demand curves to increase, along with the price and quantity.
If profit is equal to zero, there will be no entry into or exit from the industry. In the long run, all the companies' economic profits must be zero.
Monopolistic Competition and Welfare
Let's compare a company in monopolistic competition with a company in perfect competition, where both are in a long-run equilibrium. In both cases, profit equals zero. The two main differences between the two are:
Excess Capacity
companies in perfect competition produce where ATC is at a minimum (efficient scale)
companies in monopolistic competition produce where quantity of output is smaller, and on a downward sloping part of ATC (excess capacity)
could increase capacity and lower average costs
Make-up Over Marginal Cost
for a competitive firm, price = marginal cost
for a monopolistic competition firm, price > marginal cost
there is a mark-up above MC even though the firm makes zero profits
Efficient Outcomes and Externalities
When price is greater than marginal cost, the value that consumers place on the last unit is greater than the cost, so the good is under-produced. This leads to a deadweight loss like a monopolist. The number of businesses in the industry may be inefficient, and each time a new business enters, it creates externalities such as,
Product Variety Externality - consumers get a wider choice of products, and an increase in consumer surplus which is a positive externality
Business-Stealing Externality - this is a negative externality whereby other businesses lose customers
Since companies do not take these into account, there are no guarantees that there is an optimum number of them in the industry. This means that there may be too few or too many products available on the market.
Product Differentiation through Advertising
Companies that wish to differentiate products often use advertising. Advertising is common with differentiated consumer products, and much less common with homogeneous goods. Forms of advertising include television, radio, direct mail, billboards, etc. Advertising has a wide range of costs and benefits.
One cost of advertising, is that it may be mostly aimed at manipulating tastes of consumers without conveying any useful information. Advertising may also try to create differentiation within products that are actually very similar. Also, advertising tries to make demand curves less elastic, and impedes competition. This then leads to a high markup over marginal cost.
Some benefits to advertising, is that it does convey some useful information such as prices, new products, locations, etc. Advertising may also foster competition by giving more information on pricing and availability. Advertising may also be a “signal of quality”, because willingness to spend money to advertise products may be a sign that the company has confidence in its quality. This makes it rational for consumers to try such products even if content of ads is minimal. Entry Six: Two examples of Monopolistic Competition
1.) My first example of monopolistic competition for this week is one that is close to home for those of us here at Ball State University. The example is restaurants in the Village. There are a few restaurants in the Village that are very similar, yet they do offer their own competitive advantages. For example, Jimmy Johns, Pita Pit, Carters, Greeks, China Express, Locker Room, MT Cup, and Scotty’s all offer their own types of food and differentiation. However, they all target the same customers, Ball State Students. It is through monopolistic competition that these restaurants are able to compete for business in an industry that is very competitive and price sensitive.
2.) The second example I would like to use today is government subsidized housing. There are a great many houses and apartments that are government subsidized for tenants to select from. The low income properties are price sensitive, as financial resources are not abundant for the majority of the low income housing residents. Low income housing represents monopolistic housing because there is a large number of “similar products” available. However, the products are not a commodity in that each property offers differentiation, preferences, location and other factors one must consider. So while the products are very similar, they do allow for competitive advantages.
Entry Five: Further Explanation of Monopolistic Competition and Differentiation from Perfect Competition:
“Monopolistic competitions imperfect competition where many competing producers sell products that are differentiated from one another (that is, the products are substitutes but, because of differences such as branding, not exactly alike). 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] In a monopolistically competitive market, firms can behave like monopolies in the short run, including by using market power to generate profit. In the long run, however, other firms enter the market and the benefits of differentiation decrease with competition; the market becomes more like a perfectly competitive one where firms cannot gain economic profit.
I seem to have a hard time identifying examples of monopolistically competitive markets. I suppose the auto industry might qualify. Looking at car dealerships that sell new vehicles of the same make. For example, two Chevy dealerships that compete for the same customers, offering the same product. The dealership must be creative in their advertising and promotions of the similar vehicles to give the appearance of product differentiation. This can be accomplished through rebates, discounts, warranted options, and other promotions. Is this an accurate example of a monopolistically competitive market? Would a better example be car dealers that compete selling different makes of vehicles, Ford vs Chevy vs Honda?
In practice, however, if consumer rationality is low and heuristics are preferred, monopolistic competition can fall into natural monopoly, even in the complete absence of government intervention.[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 is also credited as an early pioneer of the concept.” (Wikipedia)
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.
Differentiation between perfect competition and monopolistically competitive firms:
The primary difference between perfect competition and monopolistically competitive firms is the assumption that firms produce differentiated products (Baye 299). While there are a great many products in a monopolistically competitive firm, buyers do find the products to be differentiated, which allows the firm the ability to charge a variation in price. Without the product differentiation I believe the firms would become price takers in a perfectly competitive market. Therefore product differentiation is the key difference.
Entry Four:
Long Run Monopolistic Competition
Baye p. 298
How do monopolistically competitive firms react in the long run?
According to Baye, the firms will produce at a level output in which Price > Marginal Cost. Secondly, Price will be equal to Average total cost > minimum of average cost.
First, it implies that monopolistically competitive firms produce less output than is socially desirable. This means that consumers would be willing to pay more for another unit of that good, but the producer will not produce anymore for fear of disturbing their profits.
Firms earn an economic profit of zero. They do not earn more than their opportunity cost of producing.
As well, the price of output exceeds the minimum point of the average cost curve. This means the firms don’t take full advantage of economies of scale in production. Baye reports that there are really too many firms in the market to enable any firm to take full advantage of economies of scale. However, some claim this is a result of product variation, and if firms did fully utilize economies of scale in production, there would be less product differentiation.
"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 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."
Entry Three:
Baye pg. 294
Taken from Baye's book, we read that there are two major differences between a monopolistically competitive market and a market serviced by monopolist. A monopolistically competitive firm faces a downward sloping demand for its products, there are other firms in the industry that sell similar products.
A monopolistically competitive industry has no barriers to entry. This implies that firms will enter the market if existing firms earn positive economic profits.
To maximize profits, a monopolistically competitive firm produces where its marginal revenue equals its marginal cost. The profit maximizing price is the maximum price per unit that consumers are willing to pay for the profit maximizing level of output.
According to Baye an industry is monopolistically competitive if:
1. There are many buyers and sellers
2. Each firm in the industry produces a differentiated product
3. There is free entry and exit of the industry
While there are substitute products in a monopolistically competitive market, the products are not perfect substitutes. An example, given by Baye, would be hamburgers from fast food restaurants. Burgers from McDonalds, Wendys and Burger King are very similar in nature, yet they all are differentiated from one another. If Wendy’s raises its prices, some customers will begin buying from other fast food chains because they see the products as being very similar. However, there will also be a group of "loyalist" to Wendys who will continue to pay the higher price.
Monopolistic competition - Daniel Kreitl
My understanding of monopolistic competition is when firms compete within in a competative market acting on the premises that they are operating within a monopoly. A firm may be able to operate in such a manner for a limited period of time. While the firm may benefit for a short period of time, the firm will not be able to operate as if it is in a monopoly for a long time. An example of monopolistice competition would be a local gas station that was priced competetivly within the market, but the station offered very poor customer service. When the customers of the station realize the poor service and that they have another option with stations down the road, the customers will leave the station with poor service. However, the station offering the poor service will be successful in the short run, just until customers find a better option. Monopolistic competition
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. In a monopolistically competitive market, firms can behave like monopolies in the short run, including by using market power to generate profit. In the long run, however, other firms enter the market and the benefits of differentiation decrease with competition; the market becomes more like a perfectly competitive
In economic theory, perfect competition describes markets such that no participants are large enough to have the market power to set the price of a homogeneous product. Because the conditions for perfect competition are strict, there are few if any perfectly competitive markets...
By: Dan Kreitl
Monopolistic competition is the middle ground between perfect competition and monopoly. A perfectly competitive firm sells a product identical to its competition and the firm is thus a price taker. A monopoly firm sells a product with no competition, and is therefore a price-setter. However, there is a lot of middle ground between the two markets, monopolistic competition, which will be shared in this paper.
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Monopoly: A monopoly is a situation in which a singlecompanyowns all or nearly all of the market for a given type of product or service. This would happen in the case that there is a barrier to entry into the industry that allows the single company to operate without competition (for example, vast economies of scale, barriers to entry, or governmental regulation). In such an industry structure, the producer will often produce a volume that is less than the amount which would maximize social welfare. (Investorwords.com) An example of a monopoly would be if Comcast was the only cable provider in an area. All residents in the area who would like cable television would be required to use the services of Comcast and would be subject to whatever price they would charge.
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Perfect Competition: "Perfect competition is one in which no participant can influence prices. The market is characterized by a free flow of information, no barriers to entry, and a large number of buyers and sellers.” (Investorwords.com) Perfect competition is “an economic model that describes a hypothetical market form in which no producer or consumer has the market power to influence prices. While monopolistic competition is inefficient, perfect competition is the most efficient, with supply meeting demand and production therefore matching this, so stock is not sat in storage for prolonged periods or going to waste.” (Market Competition Perfect and Monopolistic Competition) A close-to-home example in Indiana of nearly perfect competition would be agricultural commodities, such as corn and beans. The products are very similar between producers and the farmers have little to no influence on price because of the lack of market power in a nearly perfectly competitive market.
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Monopolistic Competition: “Monopolistic competition is a market structure in which several or many sellers each produce similar, but slightly differentiated products. Each producer can set its price and quantity without affecting the marketplace as a whole.” (Investorwords.com) An example of monopolistic competition, often eaten for breakfast, is cereal. There are many different kinds of cereal for a buyer to choose from. Often times buyers will have a preference for a certain cereal, say Captain Crunch, and are willing to pay a bit more if necessary to buy the kind and brand of cereal they prefer. However, cereal sellers must not exceed their buyer's maximum purchase price because buyers will at some price level purchase a different, but similar product in the monopolistically competitive market.
Characteristics of Monopolistic Competition:
1. Free Entry
A monopolistically competitive industry has no barriers to entry, (Baye Pg. 293). Firms can come and go within the market without significant costs. A single firm earning economic profits will be joined by competition fairly quickly due to free entry. When firms in a monopolistically competitive market are making a profit, new firms have incentive to enter the market.
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"As firms enter the market the number of products consumers can choose increases. As a result, the demand curve for each firm shifts to the left. The process of exit and entry continues until firms are earning zero profit. This means the demand curve and the average total cost curve are tangent to each other." (Monopolistic Competition- Lecture Notes)
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There are also externalities associated with entry. The product variety externality occurs because as new firms enter, consumers get some consumer surplus from the introduction of new product. (Positive Externality) However as the business stealing externality occurs because as new firms enter the market, other firms lose customers and profit. (Negative Externality) Thus, depending on which externality is larger, a monopolistically competitive market could have too few or too many firms. (Monopolistic Competition- Lecture Notes)
2. Product Differentiation
There are many firms that compete in a monopolistically competitive firm and the products are fairly similar. However, the competition is not directly head to head in that there is room within the market for firms to differentiation among products. Likewise, prices between markets will vary somewhat. “Firms have some scope to raise prices without losing all their customers as their products have some unique selling point that appeals to particular consumers.” (Applied Economics for Managers)
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An example of a similar, but unique product is book sales. Within reason, book sellers and set their own price according to the uniqueness and popularity of the book. However, there is a point where the book seller does not offer enough product differentiation to raise prices beyond a certain price. Sellers work to set output level where marginal revenue is equal to marginal cost. “The price is set using the demand curve to ensure that consumers will buy the amount produced,” (Monopolistic Competition Lecture Notes).
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3. Many Buyers and Sellers
A market in which there are many buyers and sellers means that firms must compete. Depending on how competitive a market is will determine to what degree a firm will have, or not have, pricing power. An example of a monopolistically competitive market which certainly has a large number of buyers and sellers is CD sales. With a large number of music producers and wide variety of individual music preferences, the CD market consists of many buyers and sellers.
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4. Limited Pricing Power
Because a monopolistically competitive firm is able to offer a differentiated product, the firm will have a certain degree of pricing power. Whereby, a firm offering a product that is slightly unique from its competition will have some ability to charge a higher price without losing all its buyers. However, the market is competitive enough that buyers will find a different seller if prices exceed the maximum price they are willing to pay. As a result, firms in a monopolistically competitive market must find unique ways to differentiate its products so it has some market power. “Unlike in perfect competition, the monopolistic competitive firm does not produce at the lowest possible average total cost. Instead, the firm produces at an inefficient output level, reaping more in additional revenue than it incurs in additional cost versus the efficient output level.” (authorpalace.com).
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A classic example showing how businesses work to provide product differentiation is restaurants. Restaurants differentiate from one another through advertising, offering unique dining experiences, home delivery options, unique food offerings, and by how they package and brand the company name. It is through product differentiation that many restaurants have become successful, even though the product differentiation may be settle. Restaurants competing in a monopolistically competitive market set prices higher than marginal cost because the firm has some market power. However, it should be mentioned that the markup over marginal cost is a source of inefficiency which implies deadweight loss.
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5. Downward Sloping Demand Curve
Baye's shares in our textbook a major difference between a monopolistically competitive market and a market serviced by monopolist. A monopolistically competitive firm faces a downward sloping demand for its products because there are other firms in the industry that sell similar products. To maximize profits, a monopolistically competitive firm produces where its marginal revenue equals its marginal cost. The profit maximizing price is the maximum price per unit that consumers are willing to pay for the profit maximizing level of output. (Baye, pg. 294)
Questions (1-5)
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1: What direction does the demand curve travel of a monopolistically competitive market and explain why it travels that direction.
Answer: A monopolistically competitive firm faces a downward sloping demand for its products because there are other firms in the industry that sell similar products.
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2: If a monopolistically competitive firm is earning zero economic profits what would be the relationship between price and average total cost?
Answer: P = ATC When price is equal to average total cost, the firm is earning zero economic profit.
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3: A monopolistically competitive firm has a demand curve and ATC curve that is tangent to each other. Why is it that the demand curve does not cross the ATC curve?
Answer: For the demand curve to cross the ATC curve it would mean that P > ATC at some output level.
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4: Is a monopolistically competitive market efficient or inefficient and explain why.
Answer: Markets that are monopolistically competitive fall at some point between being efficient and inefficient. The markets are somewhat efficient because there are many firms selling similar products. However, the products differentiate from one another creating some level of market power, thus creating some level of inefficiency. A perfectly competitive market is efficient and a monopoly is inefficient, with monopolistic competition in the middle.
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5: With perfect competition price is equal to marginal cost, the efficient scale. What is the relationship between price and marginal cost for monopolistic competition and why?
Answer: The relationship between price and marginal cost is that price is greater than marginal cost. This is because the firm has some market power. Firms in monopolistic competition have excess capacity because the firm could increase its output and lower its average total cost of production.
Bibliography
http://www.econ.uiuc.edu/~seppala/econ102/lect15.pdf
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Applied Economics For Managers Recitation 3 Monday June 2 1st 2004 http://ocw.mit.edu/courses/sloan-school-of-management/15-024-applied-economics-for-managers-summer-2004/recitations/rec3.pdf
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http://www.investorwords.com/3111/monopolistic_competition.html
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Alho, Kari. A GRAVITY MODEL UNDER MONOPOLISTIC COMPETITION http://www.ceps.be/ceps/download/1053
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Baye, Michael. “Managerial Economics and Business Strategy” Seventh Edition. McGraw Hill International Edition.
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“Market Competition Perfect and Monopolistic Competition” http://www.authorpalace.com/business/sales/market-competition-perfect-and-monopolistic-competition.html
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End of Paper
5 Summaries of other Wiki PapersSummary 1:
Wiki # 14 Profit & Opportunity Cost
I enjoyed reading the wiki about profit and opportunity cost. It was a well writen review of profit and opportunity costs. The paper was written in a way that was easy to read.
So often with economics things seem so simple, but then when the subject is examined more closely it becomes a far more complex entity. For example, cost is a basic financial term. However, when you read about implicit costs, explicit costs, opportunity costs, and marginal cost the terms get more complex. I was glad wiki #14 explained the terms again for more clairty.
I must say since being in grad school I am regularly thinking about the opportunity cost of nearly every decision I make. It is nice to have ample real world situations to apply the concepts of economics to.
The questions in wiki #14 were interesting and informative as well.
Summary 2:
Wiki # 5 (Green Company by James Casteel)
I thought this was a very well written wiki. I also found the graphics to be eye catching and very informative. It was an interesting topic, so it was easy to stay focused through the reading. It is interesting to consider green technology, the improvements we’ve seen over the years, and to wonder what the future will bring. I am confident we will see continued development and advancement in green technologies and renewable energy as we continue into the future.
Considering the fundamental business decisions Green Company faces, I thought James did a good job explaining the situation and potential solutions to the questions the company faced.
The end of paper questions were interesting and of sufficient difficulty.
Summary 3:
Wiki # 7 (Government Policy by Anthony Christofaro)
I really enjoyed this article because the topic was of great interest. Anthony did a great job explaining the logic and history behind his claims. He had good explanations of the case and sources he referenced.
It is interesting to consider the attempts of the government to regulate citizen actions and choices. Referencing the prohibition of alcohol, it is a large under taking to ban a widely enjoyed good. The economics of such regulation is also interesting. The cost of the government enforcing such a ban would be costly. However, the revenue generated though fines could potentially be a revenue generator for the government. I know I have heard talk of illegal possession of drugs to be reduced from an arrest, to a large fine. The thought behind this notion is that it takes police a lot of time and paper work to arrest and hold a violator of drugs. Therefore, the cost to the state is great. However, reducing the cost, and simply fining for the common violation could be a great revenue generator for the state government. It will be exciting to see how this plays out.
Good Paper!
Summary 4:
Wiki # 45 (Risk, Mean, Variance, Risk Aversion by Amy Urbanski)
I thought Amy did a great job explaining the statistical terms in her paper. She gave a detailed description of the risk measurement tools used in statistical analysis. Her questions were very informative and also challenging. I enjoyed reading her report.
I did think the paper could have been improved with more practical application and real world examples of the use of statistical analysis methods. As a student in stats class currently, I often wonder how, when, and in what fashion will I utilize the concepts and processes I am currently learning. For that reason, I enjoy reading and learning about how I may realistically use statistical analysis. However, I must admit that I have found the use of stats in my early business career to be much more evident and useful than I had ever expected during my undergrad years. With that thought, I wonder how much more I will use stats as I advance in business.
Overall, a well written, organized, and informative paper.
Summary 5:
Wiki # 43 (Pricing by Carter Sprunger)
This was perhaps the best article I have read on the wiki’s. It was very well written and very thorough. Carter gave a very good description of the terms he used and great examples when applying the concepts to real world examples.
It was interesting to read about the process of a producer determining the optimal price of their goods. The use of strategies such as markups, networks, penetration pricing, transfer pricing, limit pricing, and price matching were all insightful way in which producers work to profitably price their goods. As well the idea of raising rival costs and randomized pricing were interesting. I can’t help but wonder at what level of business are these concepts are these concepts identified and used by their economic name when pricing goods. My experience with small businesses is that while business owners naturally apply and consider these concepts, they may be oblivious to the economic concepts they are utilizing. However, I know that is a stereotype of small businesses.
The questions at the end were well thought out and challenging. This was a well written and knowledgeable use of the wiki project.
End of five Wiki summariesBlog Posts:
Entry Seven:The following article does a great job explaining monopolistic competition. Enjoy the reading and I will be following up this week with further discussion of the article.
Long Run Equilibrium
In the long run, entry and exit are both possible. If profit is greater than zero, businesses will enter, and each company's market share will fall because of more variety. As a result, each company’s demand curve will decrease, along with price and quantity. If profit is less than zero, businesses will exit, and each company’s market share will increase. This will cause the remaining companies' demand curves to increase, along with the price and quantity.If profit is equal to zero, there will be no entry into or exit from the industry. In the long run, all the companies' economic profits must be zero.
Monopolistic Competition and Welfare
Let's compare a company in monopolistic competition with a company in perfect competition, where both are in a long-run equilibrium. In both cases, profit equals zero. The two main differences between the two are:Efficient Outcomes and Externalities
When price is greater than marginal cost, the value that consumers place on the last unit is greater than the cost, so the good is under-produced. This leads to a deadweight loss like a monopolist. The number of businesses in the industry may be inefficient, and each time a new business enters, it creates externalities such as,- Product Variety Externality - consumers get a wider choice of products, and an increase in consumer surplus which is a positive externality
- Business-Stealing Externality - this is a negative externality whereby other businesses lose customers
Since companies do not take these into account, there are no guarantees that there is an optimum number of them in the industry. This means that there may be too few or too many products available on the market.Product Differentiation through Advertising
Companies that wish to differentiate products often use advertising. Advertising is common with differentiated consumer products, and much less common with homogeneous goods. Forms of advertising include television, radio, direct mail, billboards, etc. Advertising has a wide range of costs and benefits.One cost of advertising, is that it may be mostly aimed at manipulating tastes of consumers without conveying any useful information. Advertising may also try to create differentiation within products that are actually very similar. Also, advertising tries to make demand curves less elastic, and impedes competition. This then leads to a high markup over marginal cost.
Some benefits to advertising, is that it does convey some useful information such as prices, new products, locations, etc. Advertising may also foster competition by giving more information on pricing and availability. Advertising may also be a “signal of quality”, because willingness to spend money to advertise products may be a sign that the company has confidence in its quality. This makes it rational for consumers to try such products even if content of ads is minimal.
Entry Six:
Two examples of Monopolistic Competition
1.) My first example of monopolistic competition for this week is one that is close to home for those of us here at Ball State University. The example is restaurants in the Village. There are a few restaurants in the Village that are very similar, yet they do offer their own competitive advantages. For example, Jimmy Johns, Pita Pit, Carters, Greeks, China Express, Locker Room, MT Cup, and Scotty’s all offer their own types of food and differentiation. However, they all target the same customers, Ball State Students. It is through monopolistic competition that these restaurants are able to compete for business in an industry that is very competitive and price sensitive.
2.) The second example I would like to use today is government subsidized housing. There are a great many houses and apartments that are government subsidized for tenants to select from. The low income properties are price sensitive, as financial resources are not abundant for the majority of the low income housing residents. Low income housing represents monopolistic housing because there is a large number of “similar products” available. However, the products are not a commodity in that each property offers differentiation, preferences, location and other factors one must consider. So while the products are very similar, they do allow for competitive advantages.
Entry Five:
Further Explanation of Monopolistic Competition and Differentiation from Perfect Competition:
“Monopolistic competitions imperfect competition where many competing producers sell products that are differentiated from one another (that is, the products are substitutes but, because of differences such as branding, not exactly alike). 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] In a monopolistically competitive market, firms can behave like monopolies in the short run, including by using market power to generate profit. In the long run, however, other firms enter the market and the benefits of differentiation decrease with competition; the market becomes more like a perfectly competitive one where firms cannot gain economic profit.
I seem to have a hard time identifying examples of monopolistically competitive markets. I suppose the auto industry might qualify. Looking at car dealerships that sell new vehicles of the same make. For example, two Chevy dealerships that compete for the same customers, offering the same product. The dealership must be creative in their advertising and promotions of the similar vehicles to give the appearance of product differentiation. This can be accomplished through rebates, discounts, warranted options, and other promotions. Is this an accurate example of a monopolistically competitive market? Would a better example be car dealers that compete selling different makes of vehicles, Ford vs Chevy vs Honda?
In practice, however, if consumer rationality is low and heuristics are preferred, monopolistic competition can fall into natural monopoly, even in the complete absence of government intervention.[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 is also credited as an early pioneer of the concept.” (Wikipedia)
Monopolistically competitive markets have the following characteristics:
Differentiation between perfect competition and monopolistically competitive firms:
The primary difference between perfect competition and monopolistically competitive firms is the assumption that firms produce differentiated products (Baye 299). While there are a great many products in a monopolistically competitive firm, buyers do find the products to be differentiated, which allows the firm the ability to charge a variation in price. Without the product differentiation I believe the firms would become price takers in a perfectly competitive market. Therefore product differentiation is the key difference.
Entry Four:
Long Run Monopolistic Competition
Baye p. 298
How do monopolistically competitive firms react in the long run?
According to Baye, the firms will produce at a level output in which Price > Marginal Cost. Secondly, Price will be equal to Average total cost > minimum of average cost.
So what does this mean?
First, it implies that monopolistically competitive firms produce less output than is socially desirable. This means that consumers would be willing to pay more for another unit of that good, but the producer will not produce anymore for fear of disturbing their profits.
Firms earn an economic profit of zero. They do not earn more than their opportunity cost of producing.
As well, the price of output exceeds the minimum point of the average cost curve. This means the firms don’t take full advantage of economies of scale in production. Baye reports that there are really too many firms in the market to enable any firm to take full advantage of economies of scale. However, some claim this is a result of product variation, and if firms did fully utilize economies of scale in production, there would be less product differentiation.
"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 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."
Entry Three:
Baye pg. 294
Taken from Baye's book, we read that there are two major differences between a monopolistically competitive market and a market serviced by monopolist. A monopolistically competitive firm faces a downward sloping demand for its products, there are other firms in the industry that sell similar products.
A monopolistically competitive industry has no barriers to entry. This implies that firms will enter the market if existing firms earn positive economic profits.
To maximize profits, a monopolistically competitive firm produces where its marginal revenue equals its marginal cost. The profit maximizing price is the maximum price per unit that consumers are willing to pay for the profit maximizing level of output.
Entry Two:
Monopolistic Competition 2:
Baye Pg. 293
According to Baye an industry is monopolistically competitive if:
1. There are many buyers and sellers
2. Each firm in the industry produces a differentiated product
3. There is free entry and exit of the industry
While there are substitute products in a monopolistically competitive market, the products are not perfect substitutes. An example, given by Baye, would be hamburgers from fast food restaurants. Burgers from McDonalds, Wendys and Burger King are very similar in nature, yet they all are differentiated from one another. If Wendy’s raises its prices, some customers will begin buying from other fast food chains because they see the products as being very similar. However, there will also be a group of "loyalist" to Wendys who will continue to pay the higher price.
Monopolistic competition
- Daniel Kreitl
My understanding of monopolistic competition is when firms compete within in a competative market acting on the premises that they are operating within a monopoly. A firm may be able to operate in such a manner for a limited period of time. While the firm may benefit for a short period of time, the firm will not be able to operate as if it is in a monopoly for a long time. An example of monopolistice competition would be a local gas station that was priced competetivly within the market, but the station offered very poor customer service. When the customers of the station realize the poor service and that they have another option with stations down the road, the customers will leave the station with poor service. However, the station offering the poor service will be successful in the short run, just until customers find a better option.
Monopolistic competition
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. In a monopolistically competitive market, firms can behave like monopolies in the short run, including by using market power to generate profit. In the long run, however, other firms enter the market and the benefits of differentiation decrease with competition; the market becomes more like a perfectly competitive
In economic theory, perfect competition describes markets such that no participants are large enough to have the market power to set the price of a homogeneous product. Because the conditions for perfect competition are strict, there are few if any perfectly competitive markets...