monopolistic+comp

by John Wheeler
 * Monopolistic Competition**

Monopolistic competition is a market structure that has some very similar characteristics to both monopolies and to perfect competition. In a monopolistically competitive market there are many buyers and sellers, each firm in the industry produces a similar but differentiated product and lastly there is free entry and exit into and out of the industry.

One of the key differences in Monopolistic competition is that each firm has product differentiation. These differentiate product attributes can include differences in quality, color, style, location, size, safety features, taste, and packaging to name a few. Because these products are not perfect substitutes it implies that each firm faces a downward-sloping demand curve for its product. Further, this downward-sloping demand curve makes the monopolistic competitive firms demand look similar to the demand for a monopolist’s product. Another important implication is that

Some important differences, however, between Monopolistic competition and monopolies are that even though monopolistic competitive firms have similar attributes when it comes to the downward-sloping demand curve, there is still an opportunity for other firms to be in the industry and second as I mentioned before there are no barriers to entry or exit which are key characteristics of monopolies.

In the short run if a monopolistic competitive firm enters early into the industry they most likely will earn short-run profits, however, as firms begin to enter the industry those firms will begin to capture some of the market share causing more mature firms to start losing some of their share in the industry. Firms in a monopolistic competition earn zero economic profits.

code
 * The Long Run and Monopolistic Competition**

In the long run, monopolistically competitive firms produce a level of output such that

1. P > MC

2. P = ATC ( > minimum of average costs)

(Baye, 2006) code


 * Long-run Equilibrium under Monopolistic Competition**



Monopolistic competition can be seen in many areas of our economy. For example, holding all other things equal, some consumers prefer Starbucks latte’s whereas others prefer independent coffee shops latte’s. As the price of Starbucks latte’s increase, some consumers will substitute towards lattes from the independent coffee shops. However, some may stay with Starbucks even if the price is higher then its competitors.

As you have seen monopolistic competition is neither perfect competition nor a monopoly. Because there are many sellers most firms in a monopolistically competitive market experience a zero profit, however, because there is product differentiation firms have more control of pricing and profit maximizing.


 * Multiple Choice Questions:**

1. The demand curve for monopolistic competition has what type of slope? A.) upward B.) horizonal C.) vertical D.) downward

2. What kind of economic profit can a monopolistic competitve firm look at achieving in the long-run? A.) Positive B.) Negative C.) Flat D.) Zero

3. In a monopolistically competitive market what does a firm use to control pricing? A.) Strong advertising B.) Perfect substitutes C.) Product differentiation D.) None of the Above

4. Which are key characteristics of a monopolistic competition? A.) Barriers to entry B.) Free entry and exit C.) Perfect Substitutes D.) Few buyers and sellers

5. In the short-run firms that enter early into the market will most-likely enjoy which of the following? A.) Short run profits B.) Long run profits C.) Market Safety D.) None of the Above


 * Answers & Explanation:**

1.D, 2.D , 3.C , 4.B , 5.A

1. Because firm’s products are not perfect substitutes it implies that each firm faces a downward-sloping demand curve for its product

2. Because there is free entry and exit as the market matures and more and more firms join. As each firm joins it takes away a piece of market share as this continues it drives price closer to marginal cost causing the firms to face a zero economic profit.

3. Because products are not a perfect substitute within a monpolistic competitve market consumers don’t have an exact base for which to judge value so the company has more control on the pricing of a product..

4. Similar to perfect competition, firms have the ability to enter and exit the market as it they see fit.

5. Early entrance into a monopolistic market may yeild short-run gains, however, as more companies enter the market profits may decline as market share is taken away. Again we see firms being forced into a long-term zero economic profit.


 * References:**

Baye, Michael R. 2006. __Managerial Economics and Business Strategy__. McGraw-Hill/Irwin: New York, NY.

http://www.agsm.edu.au/~bobm/teaching/CE/lect10pr.pdf

http://en.allexperts.com/q/Economics-2301/hi.htm

http://www.shidler.hawaii.edu/suyder/course/vietnam/Econ4.doc