Monopolistic Competition

Monopolistic Competition

1. A type of imperfect competition such that many producers sell products that are differentiated from each other.

   • There are a large number of buyers and sellers in the market, each of which is small and acts independently. Concentration ratios are low.
   • Very low barriers to entry and exit. Existence of short term abnormal profits gives incentives to start up. Existence of short term losses gives incentives to close down.
   • Short run profit maximisers.
   • Price makers

2. Differentiation

   • Physical product: where firms use size, design, colour, shape and performance to make their products different.
   • Marketing: where firms try to differentiate their product by distinctive packaging and other promotional techniques.
   • Human capital: firm creates differences through the skill of its employees, level of training received, distinctive uniforms
   • Through Distribution: e.g. via mail order or internet shopping (Amazon)

3. Short Run: SNPs attract in new entrants, which shifts the demand curve for the existing firm's products to the left as demand becomes more elastic. This drives down price. Eventually all SNPs are eroded.

   • Firm benefits most in short run and will try to stay in the short run by innovating and further product differentiation.

4. Long Run: firms only make normal profit (AR=AC) because there are low barriers to entry and exit.

   • A stable equilibrium is never reached because new products come and go all the time and some do better than others. Existing products within a market will go through a product life cycle which affects the volume and growth of sales.

5. Efficiency

   • Firm is allocatively and productively inefficient in both the long and short run.
     • Tendency for excess capacity as firms can never fully exploit their fixed factors because mass production is difficult and they can't benefit from economies of scale. This means they are productively inefficient.
   • Allocatively inefficient because the price they charge is higher than their marginal costs.
   • The market is more efficient than monopoly but less efficient than PC. However it is more realistic than PC.
   • DYNAMICALLY efficient because there are incentives to invest in R&D and new ideas.

6. Advantages

   • No significant barriers to entry, therefore markets are relatively contestable.
   • Differentiation creates diversity, choice and utility.
   • May be dynamically efficient

7. Disadvantages

   • Some differentiation does not create utility but generates unnecessary waste e.g. excess packaging. Advertising may also be considered wasteful.
   • Allocative and productive inefficiency

8. Advertising

   • Critics argue that much of this spending is wasted and is an inefficient use of scarce resources. Environmental impact of packaging.
   • Companies use advertising to encourage brand loyalty and gain custom. Firms need to advertise to let customers know their differences from firms they are competing against. Otherwise as more companies enter the market, the individual company's demand curve might shift left (substitution effect)