Skip to main content

Microeconomics: monopolistic competition

Monopolistic Competition:

It is a market structure that has similarities with both perfect competition and monopoly.

  • Similarities with perfect competition:
    • There are multiple firms competing against each other. One common example is fast food chain restaurants.
    • Low barriers to entry. Therefore a firm can easily enter a monopolistic competitive market.   
    • In the short run, firms can earn an economic profit. In the long run, the economic profit attracts other firms up until the economic profit disappear. 
  • Similarities with monopoly:
    • Monopolistic competitive firms have the ability to set a price for their products, though changing prices affects quantity sold proportionally more than for a monopolist.
    • Each firm faces a downward-sloping demand curve due to their pricing power, but it is more elastic (i.e flatter) than for a monopolist.
    • Since each firm faces a downward-sloping demand, the marginal revenue is less than demand.
  •  Unique features:
    • In order to earn an economic profit, each firm produces a different products from their competitors. A firm's effort to differentiate its product from other firms is called product differentiation.
    • Firms spend some of their resources on advertising their products. This is done in order to create brand loyalty push the idea that their products is different than the products produced by their competitors.
Monopolistic competition in the short-run:

  • product differentiation allows a monopolistically competitive firm to earn an economic profit in the short run.
  • Product differentiation causes a firm's demand and marginal revenue to be downward sloping.
  • Firms maximize profit when producing at the quantity where the marginal revenue equals marginal cost.
  • Monopolistically competitive firms are inefficient in the short run:
    • Productively inefficient as the quantity produce is not on the lowest point of the average total cost curve.
    • Allocatively inefficient since the price earned is not equal to the marginal cost. Thus creating a dead-weight loss in the market.


Monopolistic competition in the long run:


  • As long as P>ATC (i.e positive profit), more firms want to enter the market and compete.
  • As new firms enter the market, demand for existing firm's product decreasing (demand shifts left) until no firms earn a positive economic profit.
  • Unlike in perfect competition, the long run equilibrium is neither productively or allocativelly efficient.
  • Monopolistically-competitive firms do not produce at the lowest point of the ATC. The difference between  the output at the lowest point on the ATC curve and the long run equilibrium output is called excess capacity.


References: 
Labels:
Location: New York, NY, USA

Comments

Post a Comment

Popular posts from this blog

Macroeconomics: multiplier and crowding out effects

Multiplier effect: whenever   any of the components of AD increases, the increase in GDP will be greater than the initial increase in expenditures. The impact on GDP of a particular increase in spending depends on the proportion of the new income that is taken out of the system to the proportion that continues to circulate in the economy. The multiplier effect tells us the impact a particular change in one the components of AD will have on the total income (GDP).  Let k denote the spending multiplier, which is a function of MPC and MPS. The larger the marginal propensity to consume, the larger the spending multiplier. Notice that the larger the MPC, the greater the impact a particular change in the spending variables will have on the nation's GDP. The crowding out effect: If government spending increases without an increase in taxes, the government must borrow funds from the private sector to finance its deficit, thereby increasing the interest rate. This increase in interest ...
Post a Comment
Read more

Microeconomics: Firms and cost in the short run

In Economics, the term short run refers to a time period where at least one variable of interest does not change . In our case, the short run for a firm is when at least one input  (labor, land, capital) stays fixed. Usually land and capital are considered fixed in the short run.  If an input is fixed during a period time, no matter how much the total product a firm produces, its cost stays the same. This cost is commonly known as fixed cost (FC). Examples of fixed costs: rent, property taxes, loan payments. Labor is often considered to be a part of the  variable cost (VC) . Variable cost can be defined as the cost a firm has control over during the short run. Unlike fixed cost, variable cost increases (decreases) as a firm's total product increases (decreases). Examples of variable costs include: utility bills, wages, raw materials A firm's total cost (TC) is the sum of its variable and fixed costs. As you can see, the fixed cost...
Post a Comment
Read more

Microeconomics: Factor Markets

Definition: Factor markets: markets for the factors of production (example: labor and capital). Markets are formed whenever consumers and producers meet to exchange goods or services. Deriving factor demand: the demand for goods or services in the product markets creates demand for the factors of production.  An increase (decrease) in demand for good X leads the suppliers to increase their production thereby increasing (decreasing) the demand for the factors of production.   Marginal revenue product: The demand for the factor of production is formed by multiplying a firm's marginal revenue by its marginal product.  Remember that by taking the derivative of the TR function with respect to Q we are able to find the MR. Marginal product on the other hand is found by taking the derivative of the production function with respect to a factor of production (L or K for example). Marginal revenue product (MRP): the change in total revenue when one more input is employed. It decrea...
Post a Comment
Read more