Name – Pawan Khatri

Roll no. – 15

ASUM

ECO ASSIGNMENT

Define monopoly and its characteristics with examples?

Monopolistic competition is a form of imperfect competition where many competing producers sell

products that are differentiated from one another (that is, the products are substitutes, but, with

differences such as branding, are not exactly alike). In monopolistic competition firms can behave

like monopolies in the short-run, including using market power to generate profit. In the long-run, other

firms enter the market and the benefits of differentiation decrease with competition; the market becomes

more like perfect competition where firms cannot gain economic profit. 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 was Edward Hastings Chamberlin in his pioneering book on the

subject Theory of Monopolistic Competition (1933). Joan Robinson also receives credit as an early

pioneer on the concept.

Monopolistically competitive markets have the following characteristics:

There are many producers and many consumers in a given market, and no business has total control

over the market price.

Consumers perceive that there are non-price differences among the competitors' products.

There are few barriers to entry and exit.

Producers have a degree of control over price.

The long-run characteristics of a monopolistically competitive market are almost the same as in perfect

competition, with the exception of monopolistic competition having heterogeneous products, and that

monopolistic competition involves a great deal of non-price competition (based on subtle product

differentiation). A firm making profits in the short run will 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 gives the amount of influence 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.

Major characteristics

There are six characteristics of monopolistic competition (MC):

product differentiation

many firms

free entry and exit in long run

Independent decision making

Market Power

Buyers and Sellers have perfect information

Product differentiation

MC firms sell products that have real or perceived non-price differences. However, the differences are not

so great as to eliminate goods as substitutes. Technically the cross price elasticity of demand between

goods would be positive. In fact the XED would be high.[5] MC goods are best described as close but

imperfect substitutes.[5] The goods perform the same basic functions. The differences are in "qualities"

and circumstances such as type, style, quality, reputation, appearance and location that tend to

distinguish goods. For example, the function of motor vehicles is basically the same - to get from point A

to B in reasonable comfort and safety. Yet there are many different types of motor vehicles, motor

scooters, motor cycles, trucks, cars and SUVs.

Many firms

There are many firms in each MC product group and many firms on the side lines prepared to enter the

market. A product group is a "collection of similar products".[6] The fact that there are "many firms" gives

each MC firm the freedom to set prices without engaging in strategic decision making. The requirements

assure that each firm's actions have a negligible impact on the market. For example. a firm could cut

prices and increase sales without fear that its actions will prompt retaliatory responses from competitors.

How many firms will an MC market structure support at market equilibrium? The answer depends on

factors such as fixed costs, economies of scale and the degree of product differentiation. For example,

the higher the fixed costs the fewer firms the market will support.[7] Also the greater the degree of product

differentiation - the more the firm can separate itself from the pack - the fewer firms there will be in market

equilibrium.

Free entry and exit

In the long run there is free entry and exit. There are numerous firms waiting to enter the market each

with its own "unique" product or in pursuit of positive profits and any firm unable to cover its costs can

leave the market without incurring liquidation costs. This assumption implies that there are low start up

costs, no sunk costs and no exit costs.

Independent decision making

Each MC firm independently sets the terms of exchange for its product. The firm gives no consideration to

what effect its decision may have on competitors.[9] The theory is that any action will have such a

negligible effect on the overall market demand that an MC firm can act without fear of prompting

heightened competition. In other words each firm feels free to set prices as if it were a monopoly rather

than an oligopoly.

Market power

MC firms have some degree of market power. Market power means that the firm has control over the

terms and conditions of exchange. An MC firm can raise it prices without losing all its customers. The firm

can also lower prices without triggering a potentially ruinous price war with competitors. The source of an

MC firm's market power is not barriers to entry since there are none. An MC firm derives it's market power

from the fact that it has relatively few competitors, competitors do not engage in strategic decision making

and the firms sells differentiated product.[10] Market power also means that an MC firm faces a downward

sloping demand curve. The demand curve is highly elastic although not "flat".

Perfect information

Buyers know exactly what goods are being offered, where the goods are being sold, all differentiating

characteristics of the goods, the good's price, whether a firm is making a profit and if so how much.[11]

Inefficiency

There are two sources of inefficiency in the MC market structure. First, at its optimum output the firm

charges a price that exceeds marginal costs, The MC firm maximizes profits where MR = MC. Since the

MC firm's demand curve is downward sloping this means that the firm will be charging a price that

exceeds marginal costs. The monopoly power possessed by an MC firm means that at its profit

maximizing level of production there will be a net loss of consumer (and producer) surplus. The second

source of inefficiency is the fact that MC firms operate with excess capacity. That is, the MC firm's profit

maximizing output is less than the output associated with minimum average cost. Both a PC and MC firm

will operate at a point where demand or price equals average cost. For a PC firm this equilibrium

condition occurs where the perfectly elastic demand curve equals minimum average cost. An MC firm’s

demand curve is not flat but is downward sloping. Thus in the long run the demand curve will be tangent

to the long run average cost curve at a point to the left of its minimum. The result is excess capacity

Problems

While monopolistically competitive firms are inefficient, it is usually the case that the costs of regulating

prices for every product that is sold in monopolistic competition by far exceed the benefits; the

government would have to regulate all firms that sold heterogeneous products—an impossible proposition

in a market economy. A monopolistically competitive firm might be said to be marginally inefficient

because the firm produces at an output where average total cost is not a minimum. A monopolistically

competitive market might be said to be a marginally inefficient market structure because marginal cost is

less than price in the long run.

Another concern of critics of monopolistic competition is that it fosters advertising and the creation

of brand names. Critics argue that advertising induces customers into spending more on products

because of the name associated with them rather than because of rational factors. This is disputed by

defenders of advertising who argue that

(1) Brand names can represent a guarantee of quality, and

(2) Advertising helps reduce the cost to consumers of weighing the tradeoffs of numerous competing

brands. There are unique information and information processing costs associated with selecting a brand

in a monopolistically competitive environment. In a monopoly industry, the consumer is faced with a single

brand and so information gathering is relatively inexpensive. In a perfectly competitive industry, the

consumer is faced with many brands. However, because the brands are virtually identical, again

information gathering is relatively inexpensive. Faced with a monopolistically competitive industry, to

select the best out of many brands the consumer must collect and process information on a large number

of different brands. In many cases, the cost of gathering information necessary to selecting the best brand

can exceed the benefit of consuming the best brand (versus a randomly selected brand).

Evidence suggests that consumers use information obtained from advertising not only to assess the

single brand advertised, but also to infer the possible existence of brands that the consumer has,

heretofore, not observed, as well as to infer consumer satisfaction with brands similar to the advertised

brand.

Examples

In many U.S. markets, producers practice product differentiation by altering the physical composition,

using special packaging, or simply claiming to have superior products based on brand images and/or

advertising. Toothpastes and toilet papers are examples of differentiated products. Some of the Indian

example of monopolistic competition are Indian Railways, Indian post etc.

References and Bibliography

1.  Monopolistic Competition. Encyclopedia Britannica. 

2.  Joshua Gans, Stephen King, Robin Stonecash, N. Gregory Mankiw (2003). Principles of

Economics. Thomson Learning.

3.  Hirschey, M, Managerial Economics Rev. Ed, page 443. Dryden 2000.

4.  Krugman & Wells: Microeconomics 2d ed. Worth 2009.

5.  Samuelson, W & Marks, S: 379. Managerial Economics 4th ed. Wiley 2003.

6.  Perloff, J: Microeconomics Theory & Applications with Calculus page 485. Pearson 2008.

7.  Colander, David C. Microeconomics 7th ed. Page 283. McGraw-Hill 2008.