Monopolistic Competition

Lecture Plan
Introduction

Features of Monopolistic Competition Identification of industry Demand and Marginal Revenue Curves of a Firm Price and Output Decisions in Short Run Price and Output Decisions in Long Run Monopolistic Competition and Advertising Comparison between Monopolistic Competition, Monopoly and Perfect Competition

Objectives
To understand the nature of imperfect competition or monopolistic competition. To analyze the pricing and output decisions of a monopolistically competitive firm in the short run and long run. To comprehend why a firm in monopolistic competition operates with excess capacity. To understand the rationale behind advertising for the unique product of a monopolistically competitive firm.

Introduction
Introduced by Joan Robinson (The Economics of Imperfect Competition, 1933) and Edward H. Chamberlin (The Theory of Monopolistic Competition, 1933) It is a market situation in which a relatively large number of producers offer similar but not identical products. A combination of perfect competition and monopoly. Imperfect competition because a large number of sellers sell heterogeneous or differentiated products and buyers have preferences for specific sellers. Monopolistic, because each of these sellers makes the product unique by some differentiation and has control over the small section of market, just like a monopolist.

Brands of toothpastes in India

Colgate: offers all round dental protection Promise: first to highlight the adv of clove oil Close up: (1st gel toothpaste to be launched in India),offers goodness of milk calcuim Meswak: offers ayurvedic content Babool: features natural toothpaste containing ayurvedic and medical benefits of babool tree

Apparels industry
Van Huesen :offers workwear John Millers: offers cool pant range of trousers to keep you cool Raymonds :offes Formal is not boring range Allen Solly: boasts of light colours and ecofriendly formal mens wear Arrow: tragets professional power dressing And the list goes on n on!!!!!!!!!!!

Features of Monopolistic Competition

Chamberlin: Monopolistic competition is a challenge to the traditional viewpoint of economics that competition and monopoly are alternativesBy contrast it is held that most economic situations are composites of both competition and monopoly. Features: Large number of buyers and sellers:.. Heterogeneous products.
A differentiated product enjoys some degree of uniqueness in the mindset of customers, be it real, or imaginary.

Selling costs exist Independent decision making. Imperfect knowledge. Unrestricted entry and exit.

Poultry industry: caselet

A good example of how product differentiation can turn a product sold in perfectly competitive market into one in which a seller is able to exercise some degree of market power is the case of poultry industry Poultry industry in India was fragmented, regional and localized with small poultry farms operating, the level of competition being reasonable even across regions. The small players gave low priority to quality standards and hygiene. Godrej Agrovet, started in 1971was the largest producer of animal feed in the country. In 1998,it pioneered the concept of processed chilled chicken by launching the Real Good brand of chicken.

 This was the first time any brand was associated with the poultry industry. Real Good Chicken was priced higher than the local, unbranded, frozen or live chickens. It was promoted for its tenderness. Ad line was It is more juicy, marinates better and easy to cook Hygiene and freshness emphasized by the fact: it was sealed, sold with correct weight and date of packaging printed. Real Good Chicken created a segment for itself. It reestablished its position in 2004 to achieve greater acceptance among consumers by driving home the point chilled not frozen through TVC.

 It soon spread to other parts of South India from Bangalore to Chennai to Hyderabad, Mumbai and Goa In the eastern part of India Arambagh Hatcheries,estb in 1973 launched Arambagh Chicken in 1992-93 through aggressive TVC in the afternoon targeting bengali housewives. It went a step further and introduced fried chicken, tandoori chicken, kebabs, drumsticks and a whole range of ready to eat items at its specialised retail outlets like mini super markets. Interestingly, these items were sold for not more than Rs 25 per portion. Arambagh Hatcheries also attracted a large number of customers interested in buying at the lowest price with consistent quality and stability of supply

 Kenilworth Hotel in Kolkata was one of its earliest big buyers. The company negotiated long term price contracts with these large buyers and protected itself from large competitive markets Arambagh Hatcheries has grown from Rs 8crores in 1992 to Rs 150 crores in 1998 Some other players who entered the market and used product differentiation as a sales strategy are Suzannes of Kerala, Suguna of Coimbatore and Al Kabir of Chennai

Demand and Marginal Revenue Curves of a Firm

Price, Revenu e

M R

A R

Normal downward sloping demand curve (AR Curve) as all the firms in the industry sell close substitutes. Demand is highly elastic and slope of demand curve is flatter
If a firm increases the price of its product slightly, it will lose some, but not all of its customers. if it lowers the price slightly, it will gain some, but not all of the customers of its rivals.

Quanti ty

MR curve lies below AR curve

Price and Output Decisions in Short Run

Joan Robinson: Each firm has a monopoly over its product.
When product is differentiated, firm has some monopoly power.

Firms have limited discretion over price, due to the existence of consumer loyalty for specific brands. Negative slope of the demand curve that is instrumental for chances of monopoly profits in the short run. The reason for supernormal profit in short run, is supplying a product which is differentiated, or at least perceived to be different by the consumer.

Price & Output Decisions in Short Run

Firm maximizes profit where (i) MR=MC; (ii) MC cuts MR when MC is rising. Profit maximising output OQE and Price OPE
Price, Revenu e, Cost
M C

PE
A

A C

E
A R

QE

M R Quanti ty

Total revenue = OPEBQE Total cost =OAEQE Supernormal profit =APEBE since price OPE > OA (AR>AC)

Price & Output Decisions in Short Run

Firm maximizes profit where (i) MR=MC; (ii) MC cuts MR when MC is rising. Profit maximising output OQE and Price OPE
Price, Revenu e, Cost
M C

E B

PE

A C

QE

M R Quanti ty

A R

Total revenue = OPEBQE Total cost =OAEQE Loss =APEBE since price OPE < OA (AR<AC)

Price & Output Decisions in Long Run

Firm maximizes profit where (i) MR=MC; (ii) MC cuts MR when MC is rising. Profit maximising output OQE and Price OPE
Price, Revenu e, Cost
M C

PE

A C

QE

M R Quanti ty

A R

Total revenue = OPEBQE Total cost =OAEQE Normal profit = No loss no gain since AR=AC

Price & Output Decisions in Long Run

Just like perfect competition, in monopolistic competition too all the firms would earn normal profits in the long run. In the long run supernormal profit would attract new firms to the industry till all the firms earn only normal profits. Losses, will force firms to exit the industry till remaining firms in the market earn only normal profits. If all the firms only normal profit there will be no tendency to enter or exit the market.

Monopolistic Competition and Advertising

Advantages
Since there are a large number of sellers, offering a unique brand, customers need to collect and process information on such large number of brands. It is more profitable to attract customers through advertising rather than by lowering price. Advertising induces customers to pay a premium for the particular brand, termed brand equity in marketing. Advertising is to shift the demand curve of one particular firm, at the expense of other firms that are offering similar products.

Monopolistic Competition and Advertising

Criticism: Advertising induces customers into spending more, because of the brand, rather than rational factors. A wasteful expenditure that adds no value to the product Leads to brand confusion in the minds of the consumers. Advertisements of rival products may even cancel each other, leading to increase in average costs of each firm, without any corresponding increase of sales. Optimal Level of Advertising MR derived from advertising=MC of advertising MRA=MCA

Comparison with Monopoly and Perfect Competition

Firms are in equilibrium and earning normal profit AR=AC
Price, Revenue, Cost

LAC

PM PMC PC

EM EM
C

EC

DC

DM O QM QMC QC

DMC
Quantity

Excess Capacity

Perfect competition: horizontal demand curve (DC); output QC; price PC Monopolistic competition: downward sloping highly elastic demand curve (DMC); output QMC (< QC), at price PMC (> PC). Monopoly: downward sloping less elastic curve D M; output Q M (< QC and QMC), at price PM (> PC and PMC). Monopoly and monopolistically competitive firm operate at less than optimum output and charge a higher price. Excess capacity due to market imperfections= QC> Q MC >QM

Summary
Most firms compete with each other and have some (if not full) degree of market power. Thus they lie somewhere between the two extremes of monopoly and perfect competition. Joan Robinson of Cambridge and Chamberlin of Harvard independently came up with a new concept of market, which Robinson referred to as imperfect competition and Chamberlin termed as monopolistic competition. A monopolistically competitive has features like large number of buyers and sellers, heterogeneous product, selling costs, independent decision making, imperfect knowledge, unrestricted entry and exit. It is difficult to define an industry in case of monopolistic competition as firms sell differentiated products. Alternatively, we identify groups of differentiated products in this type of market, by clubbing close substitutes from the same industry and regard them as product groups.

Summary
Firms under monopolistic competition have a normal demand curve with a negative slope because of substitution effect of heterogeneous products, which are close substitutes of each other. They may generate supernormal profits or normal profits, or may even incur losses in the short run. In the long run all firms earn normal profits due to the feature of unrestricted entry and exit. It is profitable for to attract customers through advertising rather than by lowering the price. A firm in perfect competition is able to efficiently allocate its resources by maximizing producer and consumer surplus, though a monopolist and a monopolistically competitive firm operate at less than optimum output, and charge a higher price.