Download Economics: Unit 4: Monopolistic competition - Cyro - Cs

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Economics: Unit 4: Monopolistic competition
M onopolistic competition has many characteristics from perfect competition and
the characteristic ofproduct differentiation from a M onopoly. W hilst first are price
makers they are no absolute price makers as there are many smallfirms and no firm
has a significant market share.
The demand curve for monopolistic competitors is elastic as there are many firms,
w hereas the monopolists is much more inelastic due to the lack ofclose
substitutes. The follow ing diagram can be used to show the cost structure ofa
monopolistic competitor in the short run,w here the shaded area represents
supernormalprofits.
Price and
costs
MC
A TC
Pm
= Supernormalprofits
AC
MC
OF LAST UNIT
MR
O
D = AR = P
Qm
Q
In the long run the demand curve for the individualfirm w illshift to the left,as
more firms w illbe producing more differentiated products. This assumes that the
market demand remains constant and that demand for the product remains the
same as the new firms enter the market.
Price and
costs
MC
A TC
Pm
= Reduction in consumer
surplus
Po
MR
O
Qm
D = AR = P
Qo
Q
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This shifting ofthe demand curve stops at a point w here the demand curve is
tangentialto the A TC curve. There is then a single price and quantity at w hich the
firm can produce to break even. N o supernormalprofits are made as A R = A TC. A t
any other output A TC >A R,so the firm w illmake losses.
Efficiency in Monopolistic competition
Qo,the optimum output for society is greater than Qm,so the market is not
productively efficient. Qo – Qe is the excess or unused capacity ofthe firm. This is
due to idle capitalas the firm has had a reduce production as more firms enter the
market.
Pm > M C,so the market is not allocatively efficient.
To utilise this capacity market demand must increase or firms must leave the
market. This w illincrease demand for the product from the individualfirm and so
utilise some ofthe firm’s excess capacity.
In monopolistic competition consumer surplus is reduced by the shaded region in
the above diagram. The consumer is over charges and the firm produces an output
below the optimum.
Competition in Monopolistic competition
In monopolistic competition there is lots ofnon-price competition. The firm can
compete on its product through differentiation,the place it sells the product
through effective and appropriate distribution and promotion to improve product
know ledge such as specialoffers,advertising and after sale service.
Past paper Q uestion
June 2002,Q3.
The existence ofmany smallhigh street travelagents,each w orking w ellbelow
capacity,is a sign ofinefficiency.
(a) U sing diagrams,explain the short ad long run equilibrium positions ofa
firm in monopolistic competition.
M onopolistic competition is a market structure in w hich firms are price makers,
there are a large number ofsmallfirms producing differentiated products and
there are no barriers to entry in the long run.
First producing under this structure are making supernormalprofits in the short
run. The firm has a dow nw ard sloping demand curve and are aiming to maximise
profits so product at M C = M R,as show n below . The shaded area represents the
supernormalprofits made in the short run.
Gareth Jones - http://cyro.cs-territories.com/
Price and
costs
MC
A TC
Pm
= Supernormalprofits
AC
MC
OF LAST UNIT
MR
O
D = AR = P
Qm
Q
In the long run supernormalprofits attract new entrants into the market so reduce
the demand for each firm,assuming aggregate demand in the market remains
unchanged. This erodes profits and leaves under utilised capacity or Qo-Qm,as
show n below .
Price and
costs
MC
A TC
Pm
Po
MR
O
Qm
D = AR = P
Qo
Q
(b) D iscuss the view that greater efficiency w ould result ifthe travelagent
industry show ed more characteristics ofa monopoly.
The market structure in w hich the travelagent is operating has many
characteristics ofmonopolistic competition. There are differentiated products as
different firms offer different types ofholiday,there are low barriers to entry as an
individualcan set up a company and operate it from home. The Internet has also
improved information so near perfect information exists in the market as prices
and holidays are easily comparable on the Internet. There are a large number of
smallfirms operating in the market and the market has some other characteristics
such as brand loyalty typicalofmonopolistic competition.
The market for travelagents therefore has most ofthe characteristics ofa
monopolistically competitive market. This means that there are too many firms in
the market,as competition requires allfirms to produce w ith excess capacity.
Gareth Jones - http://cyro.cs-territories.com/
Ifthe market structure w ere a monopoly the firm w ould be an absolute price maker
so could exploit the consumer by over charging them and producing an output
low er than the socialoptimum. Through price discrimination policies the
monopolist can reduce consumer surplus. A s there is no competition the firm can
supply an inferior quality product and operate inefficiently due to the barriers to
entry in the market that prevent new entrants.
The firm w illcharge a price higher than the M C so the firm is not allocatively
efficient and the lack ofcompetition does not force the firm to produce at the
low est point on it’s A TC curve.
H ow ever in the long run under monopolistic competition no supernormalprofits
are made,w hereas under a monopoly supernormalprofits are sustained in the
long run due to the barriers to entry. These supernormalprofits can be used for
research and development,w hich in the case ofthe travelagent could be research
into new holiday destinations.
A pure monopolist can also reduce priced by exploiting economies ofscale,
especially marketing economies ofscale by renting entire hotels through the
holiday season. This reduces the firm’s costs so low ers the marginaland average
totalcost curves. The monopolist can pass on this reduction in costs to the
consumer in the form oflow er prices.
A pure monopolist may also operate more efficiently in the long run than a
monopolistic competitor as a monopolistic competitor w illhave excess capacity as
there are too many firms in the market w hereas a pure monopolist w illnot have
excess capacity.
In conclusion neither market structure w illresult in greater efficiency,as both
market structures are inefficient in the long run. H ow ever,a monopolistic
competitor faces competition and this forces them to become more efficient than a
pure monopolist w ho faces no pressure to become efficient,pass savings onto
consumers or invest supernormalprofits in research and development.
The market structure ofthe travelagent market is more accurately represented by
the oligopoly market structure as a few large firms dominate the market w ith a
large number ofsmalltravelagents specialising in particular holidays.
These notes are from lessons on 29/09/2004 and 06/10/2004.