Approach to Modeling Monopolistic Competition - Essay Example

Macro & Micro economics By Due The concept of elasti holds great importance in pricing strategies. It measures the degree of responsiveness to a change. Price elasticity calculates the change in demand with a unit change in price (Marshall, 1890). In an economic system, every firm wants to maximize its profit and minimize its total cost. There are different types of market in an economy and the decisions made by firms vary according to the market in which they operate. In perfectly competitive markets, a change in price draws immediate response from the competitors. Firms face perfect elasticity in perfect competition. They are price takers and cannot change it. If a firm raises the price of its product, the demand for its product lowers immediately. Also, the competitors do not bring any change in their prices. The little portion of demand that the firm has prior to the change in price gets redirected to the competitors. The firm ends up earning no excess profits at all (Samuelson, 1948). Therefore, the firm has to lower the price again. When the firm lowers the price of its product, it experiences an immediate rise in demand. But this increase in demand is very short-lived because the competitors react quickly by lowering their prices too. Therefore, all the firms end up earning less income than before. This is why price remains static in a perfect competition. It is difficult to find absolute examples of perfect competition in the real world but there are a few possible approximations (Kreps, 1990). Fish markets are believed to be perfectly competitive but Graddy found out that it might not be true (1995). But her findings are limited to Fulton Fish Market in New York and they may not be applicable generally. Vegetable and fruit vendors can also be regarded as operating in a perfectly competitive market. Such sellers sell very close to each other and a buyer can easily go to another seller if one seller charges higher. If a seller charges lower, it is very easy for other sellers to find out. Therefore, they also lower their prices at once. In a monopolistic competition, the producers differentiate their products through various methods so that the products do not become perfect substitutes for each other (Roberts, 1987). An MC firm has the ability to control its share of the market and is a price setter. However, the demand for its product is still very elastic. It can raise its price but the excess profits are often short term. The consumers realize that they can substitute the product of the firm. This is why an MC firm differentiates its product through branding and advertisement. It promulgates the fact that its product is superior to that of the competitors. In real life, products like toothpaste, washing powders etc are differentiated from each other through advertisements in which they are shown as the best. They try to manipulate the thinking of the consumer so that the demand for the product becomes relatively inelastic (Davies & Cline, 2005). Big MC firms often raise their prices when they know that their product would be bought anyway. However, the demand gradually falls and the firms have to lower their prices to attract the lost consumers again. Monopolistic competition can be observed in the restaurant business, hotels, pubs, and consumer services (Economics Online, n.d). Big restaurants and hotels can easily charge higher because they have a reputation through their good service. In hairdressing business, firms try to differentiate themselves by providing better service. When they charge higher, there is a fall in demand in the long term. But they earn supernormal profits in the short term. The ability to differentiate makes the firms able to ‘make’ the price than ‘take’ it. In oligopoly, there are very few firms that compete in the market. They face a tough competition as they receive an immediate response when they change their prices. A raise in price becomes a gift for the competitors. When the price is lowered, the demand increases but the competitors also lower their prices and the demand falls back to its original level. Generally, sellers in an oligopoly have a kinky demand curve (Samuelson, 1948). Demand above the kink (equilibrium price) is relatively elastic as the competitors never respond if a firm raises its price above the kink. Price is relatively inelastic below the kink but the competitors respond immediately to regain their market share. However, sellers in oligopoly often enjoy high prices as the product that they produce is very limited. The biggest example of oligopoly is the Big Four, the four major companies that control the accountancy market (Datamonitor, 2008). PriceWaterhouseCoopers, KPMG, Deloitte Touche Tohmatsu, and Ernst & Young do not usually change their charges but they strive hard to beat each other by providing high quality service. Surveys are often conducted that rank the top accounting firms in the world. The No. 1 firm gets to charge higher on the grounds that their service is the best in the world. However, the change in their fee is not too high because the competition is very stiff and the customers can easily go to other audit firms. Kraft Foods, PepsiCo and Nestlé have global oligopoly over the market processed foods. Microsoft, Sony, and Nintendo dominate the video game console market. In US, The Walt Disney Company, CBS Corporation, Viacom, Comcast, Hearst Corporation, Time Warner, and News Corporation control the television and high speed internet market (George, 2008). Unilever and Procter & Gamble dominate the detergent market in UK (Datamonitor, 2008). In all the above oligopolies, there is great competition among the rivals and there is a price war. For instance, the television companies consistently look to create good TV shows to achieve high rating. Better TV shows attract the audience which is why they obtain high paying sponsors and earn high revenue through advertisements. In a monopoly, firms do not have to worry about competition at all. There is only one firm in a monopoly that makes all the decisions. There are various barriers to entry in this market which makes sure that there will be no competitor. Demand is highly inelastic in a monopoly as the consumers have no substitute for the product (Hirschey, 2000). A monopolist earns supernormal profit in the long run. It can easily raise the price of the product as there is almost no change in demand. Electric supply companies enjoy a monopoly as they are often Government owned. They can raise their prices but the demand remains the same. The Government makes sure that there is no competitor in this market (Samuelson & Marks, 2005). Price elasticity, therefore, is a huge factor in devising pricing strategies. Firms have to be aware of the decisions made by their competitors at all times. Changes in price have different responses in different markets. Hence, firms should understood and accept their roles in a market whether they are price makers or price setters. References Accountancy Industry Profile: Global, Datamonitor, September 2008. Davies A & Cline T 2005, ‘A Consumer Behavior Approach to Modeling Monopolistic Competition’, Journal of Economic Psychology 26 (6): 797–826. George R 2008, Mass Media in a Changing World, New York (2nd ed.), McGraw Hill. Graddy, K 2006. ‘Markets: The Fulton Fish Market’, Journal of Economic Perspectives, 20(2): 207-220. DOI: 10.1257/jep.20.2.207. Hirschey, M 2000, Managerial Economics, Dreyden. Kreps, D. M 1990, A Course in Microeconomic Theory, New York: Harvester Wheatsheaf. Marshall, A 1890, Principles of Economics. Vol. 1, London: Macmillan. ‘Monopolistic Competition’ n.d, Economics Online, viewed 18 March 2014, https://economicsonline.co.uk/Business_economics/Monopolistic_competition.html Roberts, J 1987. Perfectly and imperfectly competitive markets, The New Palgrave: A Dictionary of Economics. Samuelson, P. A 1948, Economics: An Introductory Analysis, McGraw-Hill. Samuelson, W & Marks, S 2005, Managerial Economics (4th ed. ed.). Wiley. p. 376. Textile Washing Products Industry Profile: United Kingdom, Datamonitor, November 2008. Read More