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DBA3301 Economics BA Discipline Discipline Module Team (Economics) PowerPoint Presentation
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DBA3301 Economics BA Discipline Discipline Module Team (Economics)

DBA3301 Economics BA Discipline Discipline Module Team (Economics)

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DBA3301 Economics BA Discipline Discipline Module Team (Economics)

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  1. │ Lecture13 │ DBA3301 Economics BA Discipline Discipline Module Team (Economics) Monopolistic Competition

  2. Reference Parkin, M., Economics 8th edition • Chapter 13, pp.285-291

  3. Learning Objectives Students are able to: • identify the characteristics of monopolistic competition • explain price and output decisions of monopolistic competition • interpret the advantages and disadvantages of monopolistic competition

  4. 1. Characteristics of Monopolistic Competition • A large number of sellers • Freedom of entry and exit • Product differentiation • Firms compete in price, quality and marketing

  5. 1. Large number of sellers • The presence of a large number of sellers in the market implies: • Each firm has only an insignificant (small) market share and therefore has limited market power to influence the price of its products • Each firm is sensitive to the average market price, but no firm pays attention to the actions of the other, and no one firm’s actions directly affect the actions of other firms • Collusion, or conspiring to fix prices, is impossible (i.e. independence of firms)

  6. 2. Freedom of entry and exit • There is no barrier to entry in monopolistic competition, so firms cannot earn an economic profit in the long run

  7. 3. Product Differentiation • Firms in monopolistic competition practice product differentiation, which means that each firm makes a product that is slightly different from the products of competing firms e.g. differences in quality, design, brand, packaging, sales location, services, etc. • Products are close substitutes, NOT perfect substitutes

  8. 4. Firms compete on price, quality and marketing • Product differentiation enables firms to compete in 3 areas: • Price - since firms produce differentiated products, each firm has a downward-sloping demand curve for its own product (i.e. a firm that can make a high-quality product can charge a higher price) • Quality - includes design, reliability and service • Marketing - differentiated products must be marketed using advertising and packaging

  9. 2. Demand Curve in Monopolistic Competition • Because of product differentiation, a firm can raise its price without losing all its customers(Remember that in perfect competition, a firm loses all customers if it raises its price) • Therefore, • demand curve is downward sloping because price rise results in loss of some, NOT all, customers • demand curve is relatively elastic because of substitutes from other firms

  10. 2. Demand Curve in Monopolistic Competition • However, the actual elasticity depends on the degree of product differentiation • Generally, the less differentiated the product, the more elastic the demand and vice versa • Hence, product differentiation is a means to decrease demand elasticity

  11. 3. Price and Output Determination 3.1 Short run • The profit maximizing quantity is : the output level at which MR = MC • Price is determined from the demand curve at the profit maximizing quantity • The firm can make normal profit, economic profit or loss depending on the difference between average revenue (Price) and average total cost (ATC)

  12. 3. Price and Output Determination • Fig. 13.2 shows a short run equilibrium for a firm in monopolistic competition • It operates much like a single-price monopolist

  13. 3. Price and Output Determination • The firm produces the quantity at which MR=MC and sells that quantity for the highest possible price • It earns an economic profit (as in this example) when P > ATC

  14. 3. Price and Output Determination • A firm might incur an economic loss in the short run • Here is an example • In this case, P < ATC Profit maximizing may mean loss minimizing

  15. 3. Price and Output Determination 3.2 Long run • Zero Economic Profit • In the long run, economic profit induces entry • And entry continues as long as firms in the industry earn an economic profit – as long as (P > ATC) • In the long run, a firm in monopolistic competition maximizes its profit by producing the quantity at which MR = MC

  16. Long run Adjustment • As firms enter the industry, each existing firm loses some of its market share. The demand for its product decreases and the demand curve for its product shifts leftward • The decrease in demand decreases the quantity at which MR = MC and lowers the maximum price that the firm can charge to sell this quantity • Price and quantity fall with firm entry until P = ATC and firms earn zero economic profit • LR equilibrium is then reached (as there is no more incentive for new entrants)

  17. Long run Equilibrium • The figure shows a firm in monopolistic competition in the long run equilibrium (note that it earns zero profit) • Demand curve is tangent to the ATC curve

  18. Points to Note at the LR Equilibrium • The long run equilibrium is a position where the downward sloping demand curve is tangent to the LRAC curve. • Note that demand curve will never be tangent to the bottom of LRAC because it is downward sloping. With reference to Fig. 13.4 above, the profit maximizing output is 75 jackets and price is $50 (price is $25 in the textbook, 8th Ed.). • The firm in monopolistic competition has excess capacity as it does not produce at the capacity output (i.e. not at the least cost output of 100 jackets).

  19. Excess Capacity • Firms in monopolistic competition operate with excess capacity (the pink arrow) in long run equilibrium • The downward-sloping demand curve for their products drives this result

  20. Lower Output & Higher Price • Firms in monopolistic competition have higher price (i.e. positive markup– the vertical pink arrow) & lower output than firms in perfect competition • Again, the downward-sloping demand curve for their products drives this result

  21. 4. Disadvantages of Monopolistic Competition • Higher price, lower output owing to downward sloping demand curve • Excess capacityi.e. not producing at the minimum AC i.e. product differentiation creates excess capacity which is an inefficiency • Less scope for economies of scale than monopoly • Lack of economic profits in the long run for research and development

  22. 5. Advantages of Monopolistic Competition • Demand is highly elastic due to the presence of large no. of substitutes • Product diversity(but at the expense of excess capacity) • Greater freedom of entry • Absence of economic profits keeps price down in long run

  23. Final Remarks on Market Structure As shown in the 1st part of the slides of perfect competition, the 4 forms of market structure (perfect competition, monopoly, monopolistic competition and oligopoly) are theoretical constructs. Actual examples may only be approximations of the constructs.