USB:MBA – Industry Collaborated Programs
Subject Name- Managerial Economics
Subject Code: 20BFT617/20BBT617/20BHP606
Faculty Name: Dr. Vipin Sharma
Market Structure: Monopolistic Competition DISCOVER . LEARN . EMPOWER
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Objective
• The course aims to familiarize
Monopolistic Competition the students the concepts of
Markets form Monopolistic
Competition as it is applicable
in the real world situation.
Course Outcomes Agenda of the Lecture
CO Title Level [Link] Structure: Monopolistic
Num Competition?
ber
CO1 To introduce core concepts of Market Remember
[Link] Determination under
structure Monopolistic Competition Monopolistic Competition.
To Learn process of Price determination in
CO2
the Short Run and the Long Run
Remember [Link]’s Equilibrium under
To Learn process of producer’s equilibrium
Monopolistic Competition in Short
CO3 Remember
in the Short Run and the Long Run Run and Long Run.
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look for the answers to these questions:
▪ What market structures lie between perfect competition and
monopoly, and what are their characteristics?
▪ How do monopolistically competitive firms choose price and
quantity? Do they earn economic profit?
▪ In what ways does monopolistic competition affect society’s welfare?
▪ What are the social costs and benefits of advertising?
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Monopolistic Competition
• Monopolistic competition is a form of imperfect
competition
• It can be found in many real world markets ranging from clusters
of sandwich bars, other fast food shops and coffee stores in a
busy town centre to pizza delivery businesses in a city or
hairdressers in a local area
• Monopolistic competition is similar to perfect competition, some
economist regard it as more realistic, because the products are
differentiated
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Assumptions of the Market
1. There are many producers and many consumers - the concentration
ratio is low
2. Consumers perceive that there are non-price differences among
products i.e. there is product differentiation – competition is strong,
plenty of consumer switching takes place
3. Producers have some control over price - they are “price makers” not
“price takers” but the price elasticity of demand is higher than it would
be under a situation of monopoly
4. The barriers to entry and exit into and out of the
market are low
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Characteristics & Examples of Monopolistic
Competition
Characteristics:
▪Many sellers
▪Product differentiation
▪Free entry and exit
Examples:
▪apartments
▪books
▪bottled water
▪clothing
▪fast food
▪night clubs
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Monopolistic Competition: Falling AR and MR,
Price and Profits
Price, Cost
MC
AC
AR
MR
Output
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Monopolistic Competition:
Price, Cost
MC
P1 AC
AR
MR
Q1 Output
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Monopolistic Competition:
Price, Cost
MC
P1 AC
C1
AR
MR
Q1 Output
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Monopolistic Competition:
Price, Cost
MC
Abnormal profits
P1 AC
C1
AR
MR
Q1 Output
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A Monopolistically Competitive Firm Earning
Profits
in the Short Run
The firm faces a
downward-sloping
D curve. Price
profit MC
At each Q, MR < P. P ATC
To maximize profit, firm ATC
produces Q where MR = D
MC.
The firm uses the MR
D curve to set P.
Q Quantity
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A Monopolistically Competitive Firm With Losses
in the Short Run
For this firm,
P < ATC
Price
at the output where MC
MR = MC.
losses ATC
The best this firm can do ATC
is to minimize its losses.
P
D
MR
Q Quantity
A Monopolistic Competitor in the Long Run
• Entry and exit occurs until
Price
• P = ATC and profit = zero. MC
• Notice that the firm ATC
charges a markup of priceP = ATC
over marginal cost and markup
does not produce at
D
minimum ATC. MC MR
Q Quantity
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Long Run Equilibrium for Monopolistic Competition
Price, Cost
MC
P1 AC
Unlike monopoly, there are no barriers to
entry. This means that short run
supernormal profit attracts new
producers into the market
AR
MR
Q1 Output
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Long Run Equilibrium for Monopolistic Competition
As more firms enter the market,
Price, C ost the demand curve facing any
existing firm moves to the left MC
AC
P2
AR2
MR2
Q2 Output
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Long Run Equilibrium for
Monopolistic
Price, Cost Competition
The demand curve continues to move to the
left until it is tangential to the AC curve. At this
point, the firm is at its profit- maximising level MC
of output (because MR = MC) but is making
normal profit (because AR = AC) AC
P2
AR2
MR2
Q2 Output
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Why Monopolistic Competition Is Less Efficient than
Perfect Competition
1. Excess capacity
▪The monopolistic competitor operates on the downward-sloping
part of its ATC curve, produces less than the cost-minimizing
output.
▪Under perfect competition, firms produce the quantity that
minimizes ATC.
• Markup over marginal cost
▪Under monopolistic competition, P > MC.
▪Under perfect competition, P = MC.
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Monopolistic Competition and Welfare
▪ Monopolistically competitive markets do not have all the desirable
welfare properties of perfectly competitive markets.
▪ Because P > MC, the market quantity is below the socially efficient
quantity.
▪ Yet, not easy for policymakers to fix this problem: Firms earn zero
profits, so cannot require them to reduce prices.
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Monopolistic Competition and Welfare
▪ Number of firms in the market may not be optimal, due to external
effects from the entry of new firms:
▪The product-variety externality:
surplus consumers get from the introduction of new products
▪The business-stealing externality: losses incurred by existing
firms when new firms enter market
▪ The inefficiencies of monopolistic competition are hard to measure.
No easy way for policymakers to improve the market outcome.
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Advertising
1. So far, we have studied three market structures:perfect
competition, monopoly, and monopolistic competition. In each of
these, would you expect to see firms spending money to advertise
their products? Why or why not?
2. Is advertising good or bad from society’s viewpoint? Try to
think of at least one “pro” and “con.”
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Advertising
▪ In monopolistically competitive industries, product differentiation
and markup pricing lead naturally to the use of advertising.
▪ In general, the more differentiated the products, the more
advertising firms buy.
▪ Economists disagree about the social value of advertising.
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The Critique of Advertising
▪ Critics of advertising believe:
▪Society is wasting the resources it devotes to advertising.
▪Firms advertise to manipulate people’s tastes.
▪Advertising impedes competition –
it creates the perception that products are more differentiated than
they really are, allowing higher markups.
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The Defense of Advertising
▪ Defenders of advertising believe:
▪It provides useful information to buyers.
▪Informed buyers can more easily find and exploit price
differences.
▪Thus, advertising promotes competition and reduces market
power.
▪ Results of a prominent study:
Eyeglasses were more expensive in states that prohibited
advertising by eyeglass makers
than in states that did not restrict such advertising.
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Advertising as a Signal of Quality
A firm’s willingness to spend huge amounts
on advertising may signal the quality of its product to consumers,
regardless of the content of ads.
▪Ads may convince buyers to try a product once, but the product must
be of high quality for people to become repeat buyers.
▪The most expensive ads are not worthwhile unless they lead to repeat
buyers.
▪When consumers see expensive ads,
they think the product must be good if the company is willing to spend so
much on advertising.
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CONCLUSION
▪ Differentiated products are everywhere; examples of
monopolistic competition abound.
▪ The theory of monopolistic competition describes many markets
in the economy,
yet offers little guidance to policymakers looking to improve the
market’s allocation of resources.
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Comparing Perfect & Monopolistic Competition
Perfect Monopolistic
competition competition
number of sellers many many
free entry/exit yes yes
long-run econ. profits zero zero
the products firms sell identical differentiated
firm has market power? none, price-taker yes
D curve facing firm horizontal downward- sloping
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Comparing Monopoly & Monopolistic Competition
Monopoly Monopolistic
competition
number of sellers one many
free entry/exit no yes
long-run econ. profits positive zero
firm has market power? yes yes
D curve facing firm downward- sloping downward- sloping
(market demand)
close substitutes none many
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Economic efficiency?
• Prices are above marginal cost – meaning that the
equilibrium is not allocatively efficient
• Saturation of the market may lead to businesses being unable to exploit
fully economies of scale - causing average cost to be higher than if less
firms and products were in the market
• Critics of heavy spending on marketing and advertising argue that much
of this spending is wasted and is an inefficient use of scarce resources.
The debate over the environmental impact of packaging is linked strongly
to this aspect of monopolistic competition
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Questions???
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References
•D.N. Dwivedi, “Managerial Economic”, Vikas Publications, New Delhi.
•D. Salvatore, “Microeconomic Theory”, Tata McGraw Hill.
•D.M. Mithani, Managerial Economics Theory and Applications, Himalaya Publication, Bangalore.
•Mankiw Gregory N. (1998) : Principles of Economics, 3rd Edition, Thomson, 3rd Indian Reprint (2007).
• Pindyck, Robert S., Rubinfel : Micro-Economics, Prentice Hall of India, New Delhi.
•Daniel, L. and Gupta, P.L. (2006) 3. Maddala, G.S. and Miler Ellen : Micro-Economic Theory and Applications
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THANK YOU
For queries
Email: vipin.e9155@[Link]
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