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Monopolistic competition refers to a market situation where there are many firms selling a differentiated product. There is competition which is keen, though not perfect, among many firms making very similar products.
No firm can have any perceptible influence on the price-output policies of the other sellers nor can it be influenced much by their actions. Thus monopolistic competition refers to competition among a large number of sellers producing close but not perfect substitutes for each other.
The important features of monopolistic competition are :
i. There are large number of buyers and many sellers.
ii. Firms under monopolistic competition are price makers. They set their own prices.
iii. Firms produce differentiated products. It is the key element of monopolistic competition.
iv. There is a free entry and exit of firms.
v. Firms compete with each other by incurring selling cost or expenditure on sales promotion of their products.
vi. Non – price competition is an essential part of monopolistic competition.
vii. A firm can follow an independent price policy.
The firm under monopolistic competition achieves its equilibrium when it’s MC = MR, and when its MC curve cuts its MR curve from below. If MC is less than MR, the sellers will find it profitable to expand their output.
Under monopolistic competition
1. The demand curve is downwards sloping.
2. There are close substitutes.
3. The demand curve (the average revenue curve) is fairly elastic.
Under monopolistic competition, different firms produce different varieties of the product and sell them at different prices. Each firm under monopolistic competition seeks to achieve equilibrium as regards
1. Price and output, 2. Product adjustment and 3. selling cost adjustment.
How does a monopolistically competitive firm achieve price-output level equilibrium? The profit maximisation is achieved when MC=MR.
‘OM’ is the equilibrium output. ‘OP’ is the equilibrium price. The total revenue is ‘OMQP’. And the total cost is ‘OMRS’. Therefore, total profit is ‘PQRS’. This is super normal profit under short-run.
But under differing revenue and cost conditions, the monopolistically competitive firms many incur loss.
As shown in the diagram, the AR and MR curves are fairly elastic. The equilibrium situation occurs at point ‘E’, where MC = MR and MC cuts MR from below.
The equilibrium output is OM and the equilibrium price is OP.
The total revenue of the firm is ‘OMQP’ and the total cost of the firm is ‘OMLK’ and thus the total loss is ‘PQLK’. This firm incurs loss in the short run.
In the short run a firm under monopolistic competition may earn super normal profit or incur loss.
But in the long run, the entry of the new firms in the industry will wipe out the super normal profit earned by the existing firms. The entry of new firms and exit of loss making firms will result in normal profit for the firms in the industry.
In the long run AR curve is more elastic or flatter, because plenty of substitutes are available. Hence, the firms will earn only normal profit.
The only one condition for equilibrium in the short run : MC = MR.
The two conditions for equilibrium in the long run : MC = MR and AC = AR.
In the diagram equilibrium is achieved at point ‘E’. The equilibrium output is ‘OM’ and the equilibrium price is ‘OP’. The average revenue at the equilibrium output is ‘MQ’ and the average cost is also ‘MQ’. Thus, in the long run under monopolistic competition, there is equilibrium when AR=AC and MC=MR. It means that a firm earns normal profit. AR is tangent to the Long Run Average Cost (LAC) curve at point ‘Q’.
Generally there are five kinds of wastages under monopolistic competition.
1. Idle Capacity: Unutilized capacity is the difference between the optimum output that can be produced and the actual output produced by the firm. In the long run, a monopolistic firm produces delibourately output which is less than the optimum output that is the output corresponding to the minimum average cost. This is done so mainly to create artificial and raise price. This leads to excess capacity which is actually a waste in monopolistic competition. In diagram 5.8., MF quantity of output refers to unused capacity. If OF is produced, the society will get larger quantity with lower price.
2. Unemployment: Under monopolistic competition, the firms produce less than optimum output. As a result, the productive capacity is not used to the fullest extent. This will lead to unemployment of human resources also.
3. Advertisement: There is a lot of waste in competitive advertisements under monopolistic competition. The wasteful and competitive advertisements lead to high cost to consumers. It is also claimed that advertisements cheat the consumers by giving false. information about the product.
4. Too Many Varieties of Goods: Introducing too many varieties of a good is another waste of monopolistic competition. The goods differ in size, shape, style and colour. A reasonable number of varieties would be sufficient. Cost per unit can also be reduced, if only a few varieties are produced in larger quantity Instead of larger varieties with small quantity.
5. Inefficient Firms: Under monopolistic competition, inefficient firms charge prices higher than their marginal cost. Such type of inefficient firms should be kept out of the industry. But, the buyers’ preference for such products mostly due to emotions. enables the inefficient firms to continue to exist. Efficient firms cannot drive out the inefficient firms because sometimes the Efficient firms may not be able to Spend money on attractive advertisement to lure the buyers. In reality, the consumers are mostly emotional rather than rational, as stated by Richard Theiler, the Nobel prize winner for the year 2017.Rational decision are made by mind; emotional decisions are made by heart.
Monopsony is a market structure in which there is only one buyer of a good or service. If there is only one customer for a certain good, that customer has monopsony power in the market for that good. Monopsony is analogous to monopoly, but monopsony has market power on the demand side rather than on the supply side.
Bilateral monopoly refers to a market situation in which a single producer (monopolist) of a product faces a single buyer (monopsonist) of that product.
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