Реферат: Monopolistic competition and economic efficiency (Монополистическая конкуренция и экономическая)

MatyukhinAnton

ICEF,2nd year, 2nd group.

Tutor:Natalya Frolova.

ESSAY ON MICROECONOMICS:

Monopolistic competition and economicefficiency.

Международный институт экономики и финансов, 2 курс,

Высшая школа экономики.

Year 2000, March.

One of the most important and basic economicissues is the theory of Market Structure. The meaning of economics as a scienceis 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 amaterialistic part of life. The satisfaction, although only partial, of eithereconomic agency could not be achieved while acting without knowing something aboutthe market, on which it operates. One can not predict or expect eitherproducers’ or consumers’ behaviour without knowing general profit and utilitymaximising notions and conditions. The structure of a market provides thisinformation.

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

The markets, which combine both the pricemaking of a monopoly with a large number of suppliers and free- entryconditions of pure competition are the most popular and wide spread ones. Amongthese are almost all retail stores like record shops and clothing shops, foodfacilities like restaurants and fast-food enterprises, producers ofnon-alcoholic beverages like Coca-Cola or Pepsi and a great variety of others.Because such markets combine the features of monopoly and competition, they arecalled monopolistically competitive. This model is also very interesting andimportant 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 allconceivable commodities and there is always a problem of choice.

There are several characteristicassumptions, which identifies the monopolistic competition:

1.

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

Productdifferentiation 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 theproduct are important aspects of product differentiation.

3.

Location is another type of differentiation.

4.

Brand names, advertising and packaging lead toperceived differences.

5.

Product differentiation allows producers to have somecontrol over the prices of their products.

2.

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

3.

All participants have perfect information.

4.

No entry barriers on themarket. Neither technological nor legal barriers to entry exist. This feature issimilar to the perfect competition market.

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

ProfitMaximisation in Monopolistic Competition:

·

In SR, firm sets its outputquantity where MR = MC and sets price higher than the perfect competition firmwould 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 scaleof plant in response to SR profits.

·

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

Short-run price and output decision (no new entrants):

As any profit- maximising firm,

Monopolistic competitor(when it does not choose to shut down) produces the output where MC=MR and theresult would be economic profit (ABCD, grey area)

As it was mentioned earlier, the entry onthe market is absolutely free and definitely new firms’ occurrence affects thedemand for the particular firm’s output. First, the share and thus the profitof each firm in the market decrease with the increasing number of competitorsproducing the similar, but non-identical commodities. The demand curve for thefirms’ production shifts to the left and at an each price, a seller would beable to realise less items of its output. Second, as the quantity of similargoods’ producers increases the elasticity of a demand curve for a single firm’sproduct increases. Thus, demand curve becomes flatter with the growing quantityof close substitutes. This situation is described on the graph below:

Long-run price and output decision:

New entrants,attracted by abnormal profit, lead to the decrease of each particular firm’sproduction by decreasing the demand for it and converge its profits to zero inLR.

Process of new firmsentering the market continues until the average firm has demand tangent to theLR average cost curve (point B- the point where it can only break even). Atthis point the average total costs (ATC) are equal to average revenue(AR/demand curve), therefore in the long- run monopolistically competitivefirms usually face only normal or zero economic profit as in perfectcompetition. But there is a complicating factor involved with this analysis:some firms might achieve a measure of differentiation that is not easilyduplicated by rivals (patents, location, etc.) and can realise economic profitseven in the long run, but this is arather unusual situation.

Now, it is the very time tospeak about the monopolistic competition from the point of view of economicefficiency.

The main issue in welfareeconomics, which describes not how the economy works, but how well it works, isthe term of economic or Pareto- efficiency. By definition, “the allocation isPareto- efficient for a given set of consumer tastes, resources, andtechnology, if it is impossible to move to another allocation, which would makesome people better off and nobody worse off”. To realise the meaning ofeconomic efficiency we must also recall the definitions of allocative andproductive efficiencies:

1.

Allocative efficiency occurs when price = marginalcost (P=MC), where the right amount of resources are allocated to the product.

2.

Productiveefficiency occurs when price = average total cost (P= ATC), where productionoccurs using the least-cost combination of resources.

The monopolistically competitive firm is not allocatively efficient(misallocate resources as P > MC), but is a productively efficient market structure (P = ATC) as itmaximizes profitsandminimizes its costs.

As we see on this graph: 1.Price a firm charges its customers exceeds the marginal cost in the long- run,suggesting that society values additional units of output which are not beingproduced.

2. Firm produces the minimum cost level of output as P = ATC(average-total-cost level of output).

There is an obvious difference between thepoint where MC=MR and the price of a monopolistic competitor (on the graph itis marked as a line from A to B)- its is called a mark up. And the greater isthis mark up, the greater is the monopolistic power of a firm. Because thedemand curve is still downward sloping, the firm will not reach the long runequilibrium at the minimum point of the ATC curve. Average costs may also behigher than under pure competition, due to advertising and other costs involvedin differentiation. If there were fewer firms in industry, each firm couldproduce the more effective scale of output, which would be better forconsumers. This excess capacity is the «price» society must pay forproduct differentiation. In other words, the price differential paid by theconsumer (price difference between perfect competition and monopolistic competition)is the «price» of product differentiation. But of course monopolisticcompetition provides us many good opportunities important for our wellbeing:the lure of economic profits causes firms to develop new or improve their oldproducts in order to compete for customers with other producers of similar butnot identical goods and services.

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