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AIOU Solved Project 8406 Monopolistic Competition

ACKNOWLEDGEMENTS

This postulation is devoted to Allah, my Creator and my Master, and envoy, Mohammed (May Allah favor and give him), who showed us the motivation behind life. My country Pakistan is the hottest womb; Allama Iqbal Open University, Islamabad; my second wonderful home; My awesome guardians, who never quit giving of themselves in incalculable ways, My dearest friend, who drives me through the valley of dimness with the light of trust and support, My cherished siblings and sisters; especially my dearest sibling, who remains by me when things look disheartening, My beloved Parents: whom I can’t compel myself to quit loving. All the general population in my life who touch my heart, I commit to this research.

ABSTRACT

Monopolistic competition is a type of imperfect competition such that many producers sell products that are differentiated from one another as goods but not perfect substitutes (such as from branding, quality, or location). In monopolistic competition, a firm takes the prices charged by its rivals as given and ignores the impact of its own prices on the prices of other firms.

Unlike in perfect competition, firms that are monopolistically competitive maintain 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. AIOU Solved Project 8406 Monopolistic Competition.

Introduction

Monopolistic competition is a type of imperfect competition such that many producers sell products that are differentiated from one another (e.g. by branding or quality) and hence are not perfect substitutes. In monopolistic competition, a firm takes the prices charged by its rivals as given and ignores the impact of its own prices on the prices of other firms. In the presence of coercive government, monopolistic competition will fall into government-granted monopoly. 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 is Edward Hastings Chamberlin, who wrote a pioneering book on the subject, Theory of Monopolistic Competition (1933). Joan Robinson published a book The Economics of Imperfect Competition with a comparable theme of distinguishing perfect from imperfect competition.

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AIOU Solved Project 8406 Monopolistic Competition Monopolistically competitive markets have the following characteristics:

There are many producers and many consumers in the 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 principal goal of the firm is to maximize its profits.
Factor prices and technology are given.
A firm is assumed to behave as if it knew its demand and cost curves with certainty.
The decision regarding the price and output of any firm does not affect the behavior of other firms in a group,i.e., the impact of the decision made by a single firm is spread sufficiently evenly across the entire group. Thus, there is no conscious rivalry among the firms.
Each firm earns only normal profit in the long run.
Each firm spends a substantial amount on advertising. The publicity and advertisement costs are known as selling costs.

The long-run characteristics of a monopolistically competitive market are almost the same as a perfectly competitive market. Two differences between the two are that monopolistic competition produces heterogeneous products and that monopolistic competition involves a great deal of non-price competition, which is based on subtle product differentiation. A firm making profits in the short run will nonetheless only break even in the long run because demand will decrease and the average total cost will increase. This means in the long run, a monopolistically competitive firm will make zero economic profit. This illustrates the amount of influence the firm has 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.

AIOU Solved Project 8406 Monopolistic Competition There are six characteristics of monopolistic competition (MC):

Product differentiation
Many firms
Freedom of entry and exit
Independent decision making
Some degree of market power
Buyers and sellers do not have perfect information (Imperfect Information)^[5]^[6]

Product differentiation

MC firms sell products that have real or perceived non-price differences. However, the differences are not so great as to eliminate other goods as substitutes. Technically, the cross-price elasticity of demand between goods in such a market is positive. In fact, the XED would be high. MC goods are best described as close but imperfect substitutes. The goods perform the same basic functions but have differences in qualities such as type, style, quality, reputation, appearance, and location that tend to distinguish them from each other. For example, the basic function of motor vehicles is the same—to move people and objects from point to point in reasonable comfort and safety. Yet there are many different types of motor vehicles such as motor scooters, motorcycles, trucks, and cars, and many variations even within these categories.

Many firms

There are many firms in each MC product group and many firms on the sidelines prepared to enter the market. A product group is a “collection of similar products”. The fact that there are “many firms” gives each MC firm the freedom to set prices without engaging in strategic decision-making regarding the prices of other firms and 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.

Freedom of entry and exit

Like the perfect competition, under monopolistic competition also, the firms can enter or exit freely. The firms will enter when the existing firms are making super-normal profits. With the entry of new firms, the supply would increase which would reduce the price, and hence the existing firms will be left only with normal profits. Similarly, if the existing firms are sustaining losses, some of the marginal firms will exit. It will reduce the supply due to which prices would rise and the existing firms will be left only with normal profit.

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. 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

AIOU Solved Project 8406 Monopolistic Competition Monopolistically competitive markets exhibit the following characteristics:

Each firm makes independent decisions about price and output, based on its product, its market, and its costs of production.
Knowledge is widely spread between participants, but it is unlikely to be perfect. For example, diners can review all the menus available from restaurants in a town, before they make their choice. Once inside the restaurant, they can view the menu again, before ordering. However, they cannot fully appreciate the restaurant or the meal until after they have dined.
The entrepreneur has a more significant role than in firms that are perfectly competitive because of the increased risks associated with decision-making.
There is the freedom to enter or leave the market, as there are no major barriers to entry or exit.
A central feature of monopolistic competition is that products are differentiated. There are four main types of differentiation:
Physical product differentiation is where firms use size, design, color, shape, performance, and features to make their products different. For example, consumer electronics can easily be physically differentiated.
Marketing differentiation is where firms try to differentiate their product by distinctive packaging and other promotional techniques. For example, breakfast cereals can easily be differentiated through packaging.
Human capital differentiation is where the firm creates differences through the skill of its employees, the level of training received, distinctive uniforms, and so on.

AIOU Solved Project 8406 Monopolistic Competition Differentiation through distribution, including distribution via mail order or through internet shopping, such as Amazon.com, differentiates itself from traditional bookstores by selling online.

Firms are price makers and are faced with a downward-sloping demand curve. Because each firm makes a unique product, it can charge a higher or lower price than its rivals. The firm can set its own price and does not have to ‘take’ it from the industry as a whole, though the industry price may be a guideline, or becomes a constraint. This also means that the demand curve will slope downwards.
Firms operating under monopolistic competition usually have to engage in advertising. Firms are often in fierce competition with other (local) firms offering a similar product or service and may need to advertise on a local basis, to let customers know their differences. Common methods of advertising for these firms are through local press and radio, local cinema, posters, leaflets, and special promotions.
Monopolistically competitive firms are assumed to be profit maximizers because firms tend to be small with entrepreneurs actively involved in managing the business.
There are usually large numbers of independent firms competing in the market.

Practical study

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

Socially undesirable aspects compared to perfect competition

Selling costs: Producers under monopolistic competition are spending huge amounts on advertising and publicity. Much of this expenditure is wasteful from a social point of view. The producer can reduce the price of the product instead of spending on publicity.
Excess capacity: Under Imperfect competition, the installed capacity of every firm is large, but not fully utilized. Total output is, therefore, less than the output which is socially desirable. Since production capacity is not fully utilized, the resources lie idle. Therefore, the production under monopolistic competition is below the full capacity level.
Unemployment: Idle capacity under monopolistic competition expenditure leads to unemployment. In particular, the unemployment of workers leads to poverty and misery in society. If idle capacity is fully used, the problem of unemployment can be solved to some extent.
Cross transport: Under monopolistic competition expenditure is incurred on cross transportation. If the goods are sold locally, wasteful expenditure on cross-transport could be avoided.
Lack of specialization: Under monopolistic competition, there is little scope for specialization or standardization. Product differentiation practiced under this competition leads to wasteful expenditure. It is argued that instead of producing too many similar products, only a few standardized products may be produced. This would ensure better allocation of resources and would promote the economic welfare of the society.
Inefficiency: Under perfect competition, an inefficient firm is thrown out of the industry. But under monopolistic competition, inefficient firms continue to survive.

AIOU Solved Project 8406 Monopolistic Competition Monopolistically competitive firms are inefficient, it is usually the case that the costs of regulating prices for products sold in monopolistic competition exceed the benefits of such regulation. A monopolistically competitive firm might be said to be marginally inefficient because the firm produces an output where the average total cost is not a minimum. A monopolistically competitive market is a productively inefficient market structure because marginal cost is less than the price in the long run. Monopolistically competitive markets are also allocatively inefficient, as the price given is higher than the Marginal cost. Product differentiation increases total utility by better meeting people’s wants than homogenous products in a perfectly competitive market.

Another concern is that monopolistic competition fosters advertising and the creation of brand names. Advertising induces customers into spending more on products because of the name associated with them rather than because of rational factors. Defenders of advertising dispute this, arguing that brand names can represent a guarantee of quality and that 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 market, the consumer is faced with a single brand, making information gathering relatively inexpensive. In a perfectly competitive industry, the consumer is faced with many brands, but because the brands are virtually identical information gathering is also relatively inexpensive. In a monopolistically competitive market, the consumer must collect and process the information on a large number of different brands to be able to select the best of them. In many cases, the cost of gathering information necessary to select the best brand can exceed the benefit of consuming the best brand instead of a randomly selected brand. The result is that the consumer is confused. Some brands gain prestige value and can extract an additional price for that.

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.

Data collection methods

As mentioned earlier, research methods can be taken as a subset of research methodology. Therefore, in this section, we will discuss the broader term- methodology, which will have methods as a component of it. Organizational research is an intricate process. Daft used the metaphor ‘craft’ and ‘storytelling’ for the organizational research process. The researcher needs to explain what the data mean, using data to describe how organizations work. For this, the first condition is that the researcher needs to be creative. In research, the proper assessment of the research method to be used by the researcher becomes very important for a sound study in any area. The impact of the management studies greatly depends on the appropriateness and rigor of the research method chosen.

AIOU Solved Project 8406 Monopolistic Competition

The research methodologies are broadly categorized into two groups:

a) Quantitative Techniques

b) Qualitative Techniques

Both methods have their own advantages and disadvantages. Quantitative research is the natural science model of research. This is a positivist way of looking at things. This approach assumes that social reality is a concrete, measurable phenomenon. The supporters of this approach strictly emphasize reliability and validity as the only yard-sticks for accurate measurement. On the other hand, qualitative research is more concerned with the meaning and interpretation of data rather than the measurement of organizational phenomena. Organizations are assumed to be enormously complex social systems that also keep on changing. Hence, the approach to studying organizational phenomena needs to be different. Qualitative research procedures assume that organization realities are not concrete. The supporters of qualitative research techniques promote that direct involvement to understand the organization phenomena is necessary to understand it properly. Qualitative researchers are also likely to deal with each research setting as a unique case, assuming that each organization has a unique organizational environment and dynamic history. Qualitative researchers suggest that systematic collection and comparison of diverse cases can be a powerful means to develop and test grounded theories. Instead of adopting a quantitative approach that aggregates data across different organizations, a qualitative study that systematically compares similarities and differences in patterns of interactions, the resulting meanings of the key variables, and their influences on organizational outcomes might reveal some other important setting factors and dynamics that influence and are influenced by employees’ perception about a phenomenon.

SWOT analysis

Strengths and Weaknesses	The internal environment – the situation inside the company or organisation	For example factors relating to products, pricing, costs, profitability, performance, quality, people, skills, adaptability, brands, services, reputation, processes, infrastructure, etc.	Factors tend to be in the present
Opportunities and Threats	The external environment – the situation outside the company or organisation	For example: factors relating to markets, sectors, audience, fashion, seasonality, trends, competition, economics, politics, society, culture, technology, environmental, media, law, etc.	Factors tend to be in the future

Conclusion & Recommendations

MC firms sell products that have real or perceived non-price differences. However, the differences are not so great as to eliminate other goods as substitutes. Technically, the cross price elasticity of demand between goods in such a market is positive. In fact, the XED would be high. MC goods are best described as close but imperfect substitutes. The goods perform the same basic functions but have differences in qualities such as type, style, quality, reputation, appearance, and location that tend to distinguish them from each other. For example, the basic function of motor vehicles is the same—to move people and objects from point to point in reasonable comfort and safety. Yet there are many different types of motor vehicles such as motor scooters, motor cycles, trucks and cars, and many variations even within these categories.

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”. The fact that there are “many firms” gives each MC firm the freedom to set prices without engaging in strategic decision making regarding the prices of other firms and 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.

Freedom of entry and exit

Like perfect competition, under monopolistic competition also, the firms can enter or exit freely. The firms will enter when the existing firms are making super-normal profits. With the entry of new firms, the supply would increase which would reduce the price and hence the existing firms will be left only with normal profits. Similarly, if the existing firms are sustaining losses, some of the marginal firms will exit. It will reduce the supply due to which price would rise and the existing firms will be left only with normal profit.

Independent decision making

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 its 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 they are low. Rather, an MC firm has market power because it has relatively few competitors, those competitors do not engage in strategic decision making and the firms sells differentiated product. Market power also means that an MC firm faces a downward sloping demand curve. The demand curve is highly elastic although not “flat”. 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 marginal revenue = marginal cost. 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 a 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. A MC firm’s demand curve is not flat but is downward sloping. Thus in the long run the demand curve will be tangential to the long run average cost curve at a point to the left of its minimum. The result is excess capacity. Producers under monopolistic competition are spending huge amounts on advertising and publicity. Much of this expenditure is wasteful from the social point of view. The producer can reduce the price of the product instead of spending on publicity. Under Imperfect competition, the installed capacity of every firm is large, but not fully utilized. Total output is, therefore, less than the output which is socially desirable. Since production capacity is not fully utilized, the resources lie idle. Therefore, the production under monopolistic competition is below the full capacity level. Idle capacity under monopolistic competition expenditure leads to unemployment. In particular, unemployment of workers leads to poverty and misery in the society. If idle capacity is fully used, the problem of unemployment can be solved to some extent. Under monopolistic competition expenditure is incurred on cross transportation. If the goods are sold locally, wasteful expenditure on cross transport could be avoided. Under monopolistic competition, there is little scope for specialization or standardization. Product differentiation practiced under this competition leads to wasteful expenditure. It is argued that instead of producing too many similar products, only a few standardized products may be produced. This would ensure better allocation of resources and would promote economic welfare of the society. Under perfect competition, an inefficient firm is thrown out of the industry. But under monopolistic competition inefficient firms continue to survive. Monopolistically competitive firms are inefficient, it is usually the case that the costs of regulating prices for products sold in monopolistic competition exceed the benefits of such regulation. 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 is productively inefficient market structure because marginal cost is less than price in the long run. Monopolistically competitive markets are also allocative inefficient, as the price given is higher than Marginal cost. Product differentiation increases total utility by better meeting people’s wants than homogenous products in a perfectly competitive market.

AIOU Solved Project 8406 Monopolistic Competition

References

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^Poiesz, Theo B. C. (2004). “The Free Market Illusion Psychological Limitations of Consumer Choice” (PDF). Tijdschrift voor Economie en Management. 49 (2): 309–338.
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^Perloff, J. (2008). Microeconomics Theory & Applications with Calculus. Boston: Pearson. p. 483. ISBN978-0-321-27794-7.
^Goodwin, N.; Nelson, J.; Ackerman, F.; Weisskopf, T. (2009). Microeconomics in Context (2nd ed.). Sharpe. p. 289. ISBN978-0-7656-2301-0.
^Ayers, R.; Collinge, R. (2003). Microeconomics: Explore & Apply. Pearson. pp. 224–225. ISBN0-13-177714-9.
^ Jump up to:^a^b^c ^d ^e ^f Perloff, J. (2008). Microeconomics Theory & Applications with Calculus. Boston: Pearson. p. 445. ISBN 978-0-321-27794-7.
^Ayers, R.; Collinge, R. (2003). Microeconomics: Explore & Apply. Pearson. p. 280. ISBN0-13-177714-9.
^Pindyck, R.; Rubinfeld, D. (2001). Microeconomics(5th ed.). London: Prentice-Hall. p. 424. ISBN 0-13-030472-7.
^Pindyck, R.; Rubinfeld, D. (2001). Microeconomics(5th ed.). London: Prentice-Hall. p. 425. ISBN 0-13-030472-7.
^Pindyck, R.; Rubinfeld, D. (2001). Microeconomics(5th ed.). London: Prentice-Hall. p. 427. ISBN 0-13-030472-7.
^The firm has not reached full capacity or minimum efficient scale. Minimum efficient scale is the level of production at which the long run average cost curve first reaches its minimum. It is the point where the LRATC curve “begins to bottom out.” Perloff, J. (2008). Microeconomics Theory & Applications with Calculus. Boston: Pearson. pp. 483–484. ISBN978-0-321-27794-7.
^ Jump up to:^a^b“What’s so bad about monopoly power?”. www.cbsnews.com. Retrieved April 3, 2019.
^Antony Davies & Thomas Cline (2005). “A Consumer Behavior Approach to Modeling Monopolistic Competition”. Journal of Economic Psychology. 26(6): 797–826. doi:1016/j.joep.2005.05.003.

AIOU Solved Project 8406 Monopolistic Competition