Monopolistic competition and economic efficiency (Монополистическая конкуренция и экономическая)

Matyukhin Anton

ICEF, 2^nd year, 2^nd group.

Tutor: Natalya Frolova.

ESSAY ON MICROECONOMICS:

Monopolistic competition and economic
efficiency.

Международный институт экономики и финансов, 2 курс,

Высшая школа экономики.

Year 2000, March.

   One of the
most important and basic economic issues is the theory of Market Structure. The
meaning of economics as a science is the description and explanation of
different ways of economic agencies’ interactions through commodities,
services, mediums of exchange like money, production processes and other in
order to increase their wellbeing in a materialistic part of life. The
satisfaction, although only partial, of either economic agency could not be
achieved while acting without knowing something about the market, on which it
operates. One can not predict or expect either producers’ or consumers’
behaviour without knowing general profit and utility maximising notions and
conditions. The structure of a market provides this information.

   The theory
of Market Structure divides the markets into four most distinctive types. The
polar ones are the pure competition and pure monopoly. Between these extreme
case lie two imperfectly competitive market structures: monopolistic
competition (the one, which is closer to perfect or pure competition, and which
would be described in this essay) and oligopoly (closer to monopoly, but has
more than one but not many large operating firms, lower monopolistic power and
other distinctive features).

   The markets,
which combine both the price making of a monopoly with a large number of
suppliers and free- entry conditions of pure competition are the most popular
and wide spread ones. Among these are almost all retail stores like record
shops and clothing shops, food facilities like restaurants and fast-food
enterprises, producers of non-alcoholic beverages like Coca-Cola or Pepsi and a
great variety of others. Because such markets combine the features of monopoly
and competition, they are called monopolistically competitive.  This
model is also very interesting and important tool for analysing such issues as
product variety and product choice. It helps us understand whether the market
system leads to the production of the “right” assortment of goods and services
as it is too expensive to produce all conceivable commodities and there is
always a problem of choice.

   There are
several characteristic assumptions, which identifies the monopolistic
competition:

1.  
Sellers are price makers. The reason for this is that unlike in perfect competition where the
product is identical, there is a slightly differentiated or heterogeneous
product. Even if some firm has a monopolistic right on its trade mark and
other firms are not allowed to produce the identical commodity, they have the
opportunity to produce similar, but slightly different product and compete with
it on the market. The greater is the difference of the firm’s product from
other one’s (can be based even on location), the greater is the monopolistic
power of that firm and the less elastic is the demand curve for its output.
This feature enables it to charge a slightly different price relative to its
competitors without loosing all its customers. Product differentiation leads to
the potentiality for a firm to affect the price for the good or service it
produces. Although this ability is very limited and depends on the degree of
differentiation, a monopolistically competitive firm faces the downward
sloping demand curve like a monopoly or oligopoly (this is the main
characteristic of every imperfect competition market).

   Product
differentiation makes this model different from pure competition model.
Economic rivalry takes the form of non-price competition:

1.  
Product
differentiation may be physical (qualitative).

2.  
Services
and conditions accompanying the sale of the product are important aspects of
product differentiation.

3.  
Location
is another type of differentiation.

4.  
Brand
names, advertising and packaging lead to perceived differences.

5.  
Product
differentiation allows producers to have some control over the prices of their
products.

2.  
Sellers do not behave strategically.  As there is a large (like in perfect competition) number of small
firms, we assume, that each of them does not have a noticeable effect on the
price decision of other producers, while changing the price for its output.
Thus, firms do not take into consideration the expectation of a reaction of
their competitors to their price and output decision. Buyers & sellers are
independently acting.

3.  
All participants have perfect information.

4.  
No entry barriers on the market.  Neither technological nor legal barriers to entry exist. This
feature is similar to the perfect competition market.

    Firm's
goal is to take the pure competition’s demand curve and shift it in the
direction of the monopolist’s demand curve. It does this through price
discrimination.  Let
us now discuss the profit maximising conditions and the appropriate price-output decision in
the short and long runs.

Profit Maximisation in
Monopolistic Competition:

·    
In SR, firm sets its output quantity where MR =
MC and sets price higher than the perfect competition firm would do and equal
to the demand for this quantity of production. 

·    
If P > ATC at that output, firm earns
abnormal or positive economic profit. (Only possible in SR).

·    
Existing firms expand the scale of plant in
response to SR profits.

·    
In the LR, new firms attracted by the SR profits enter the
industry.