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Monopolistic competition

From Academic Kids

Monopolistic competition is a common market form. Many markets can be considered as monopolistically competitive, often including the markets for books, clothing, films and service industries in large cities.

Contents

Characteristics

Monopolisitcally competitive markets have the following characteristics:

  • There are many producers and many consumers in a given market.
  • Consumers have clearly defined preferences and sellers attempt to differeniate their products from those of their competitors; the goods and services are heterogeneous.
  • There are no barriers to entry and exitTemplate:Mn.

Behaviour of Firms

A monopolistically competitive firm acts similar to a monopolist in the short run. This is due to the fact that the firm faces a downward-sloping demand curve, unlike the horizontal demand curve an individual firm faces in a perfectly competitive market. The firm simply produces the quantity that maximises economic profit. This occurs at the intersection of the marginal revenue and marginal cost curves.

However, this situation does not exist for very long because as other firms notice that there is profit to be made, they will enter the market as there are no barriers to entry (unlike in a monopoly). Conversely, if firms are actually making losses, then they will exit the market. This fluctuation in supply will continue until firms are making zero economic profit (but still firms would still probably record accounting profit) and the quantity demanded is at the point on the demand curve where price equals average total cost.

Unlike in perfect competition, the price of the product is not at the point of lowest average total cost. Instead, it occurs at a higher average total cost resulting in inefficiency. This also means that the price is higher than marginal cost, creating incentive for a firm to sell to extra customers.

Problems

One critique of monopolistic competition is that having the price as higher than marginal cost creates an inefficiency. However, the costs of regulating prices for every product in that is sold in monopolistically competitive by far exceed the benefits; the government would have to regulate all firms that sold heterogenous products - an absurb proposition in a market economy.

Another concern of critics of monopolistic competition is that it fosters advertising and the creation of brand names. Critics argue that advertising induces customers into spending more on products because of the name associated with them rather than because of rational factors. This is refuted by defenders of advertising who argue that brand names are a guarantee of a product's quality.

References

Template:Mnb Joshua Gans, Stephen King, Robin Stonecash, N. Gregory Mankiw, "Monopolistic Competition", Principles of Economics , Melboune: Thomson Learning, pp. 373-387

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