Benefits of Free Trade under Monopolistic Competition - Example

Executive Summary Toyota which is in the car industry has a monopolistic competition which is characterised by many sellers with little control over the market and products which are similar with slight differentiation. This presents a strong case for Toyota to use this market structure to its advantage and look towards ways that will help to increase profits. The report looks as to why the car industry and Toyota falls into monopolistic competition and provides the reasoning for it. A literature review supporting and criticizing different aspect of monopolistic competition has been provided with. It also presents the long and short run curves and the manner in which it affects Toyota. The controversy and the benefits surrounding monopolistic competition have also been provided. Finally the reports presents an important finding for Toyota and its market structure and recommends ways that will help Toyota improve its market share and profits. Contents Introduction 3 Purpose of the report 3 Toyota in Australia 3 Monopolistic Competition 4 Assumptions 5 Literature Review 5 Short Run Monopolistic Competition 6 Long Run Monopolistic Competition 7 Controversy surrounding Monopolistic Competition 8 Benefits of free trade under monopolistic competition 9 Findings 10 Recommendations 10 Conclusion 11 References 12 Introduction Markets around the world face competition in different forms. They are perfectly competitive, monopolistic, oligopolistic and monopoly in nature. Different forms give rise to different models and present a different scenario for the real world. The report looks into the car industry in Australia and the type of competition prevalent in the economy. Toyota as the car brand has been taken and the report revolves around Toyota and its competitors. It also looks into the various short and long run curves and the effects it has on the market. Purpose of the report To identify the characteristics of the car market and based on it judge the market structure To present the manner in which the market structure affects the short and long run curves To present the benefits and controversies which surround the market structure To throw light on the finding and recommendations which will help Toyota fight competition and sustain in the market structure Toyota in Australia Toyota is in the field of manufacturing cars and has been in operation since 1980. The car industry is heavily competitive and has resulted in stiffer competition from every area. This has forced the look for newer technology and means that would reduce cost and help to improve the bottom line. This is also forcing Toyota to come up new variants of car. (Toyota, 2010) On a look the car industry looks perfectly competitive but when a deeper analysis is conducted it highlights monopolistic competition. This is due to the fact that there are several players like Ford, Mitsubishi, Hyundai and many others. A detail analysis of the reason is further provided in the report. Monopolistic Competition The car industry in Australia shows monopolistic competition. Toyota faces competition from several quarters and has limited control over the market and the products are also similar to its competitor like Ford, Hyundai etc. The following definition will further help to associate Toyota and the car industry to monopolistic competition Definition: Monopolistic competition is “a market structure which has many sellers having little control over the market and the products are very similar with very little differentiation among the products”. (Monopolistic Competition, 2010) Toyota in the car industry stands on this definition as there is competition form players like Ford, Mitsubishi, Hyundai and others. Also the control due it is little and further the products offered are similar therefore meeting the criteria of a monopolistic competition and qualifying itself as one. Assumptions Toyota in the car industry qualifies as having a monopolistic market structure due to the following assumptions Large number of firms: This is quite evident as there are many producers like Ford, Mercedes, Hyundai and others making competition level to be high Similar but Differentiated Product: The car industry witnesses this as cars of different manufacturers like Toyota and Ford are similar but have slight differentiation i their design, maintenance, mileage and other areas Substitute Product: The car industry witnesses this as increase in price of Toyota forces consumers to purchase Ford but the price match is followed by others soon leaving very little possibility to jump from one product to other. (Suranovic, 2007) Free entry and exit: This is also present due to government laws which allows many new producers come and leave the market though the cost of setting is high Economies of scale: Producing more cars help Toyota to reduce their cost as the fixed cost gets spread over larger units thereby helping to achieve economies of scale and ensure lower cost. Literature Review There are various literature studies being carried in the field of monopolistic competition and the results revealed are contrasting. A study shows that “monopolistic preference translates into properties of aggregate demand due to preference diversity”. (Raymond & Michael, 1992) This thus highlight that it leads to variety leading towards an increase in options for the consumers which finally leads towards increase in demand. A study supports this view by stating that “welfare economics due to monopolistic competition had improved export subsidies as it has helped to improve coordination”. (Lin, 1996) Another study shows that “markets are seen to have increasing returns in monopolistic competition”. (Paul, 2010) This refutes the above finding and further adds that it helps to improve the returns thereby stressing on the importance of monopolistic competition. A study also rejects monopolistic competition by stating that “it rejects the positive economics which has been substantiated by perfect competition” (Keppler, 1997) whereas another study claims the opposite by stating that “it helps to improves government spending which finally transforms into increased return”. (Michael, Allen, Lapham & Beverly, 1996) Short Run Monopolistic Competition A look at the short run curve demonstrates that Toyota has an opportunity to earn higher profits due to imperfect substitutes. (Suranovic, 2007) This is because of the fact that when Toyota launches a model of a car it takes time for the other competitor to copy or launch similar product which gives an opportunity to earn higher profits then actually warranted. This is shown in the graph below Figure 1: Short Run The above diagram is in ‘000. It shows that Toyota marginal curve (MR) is falling as more units is produced and Average Cost (AC) first falls and then rises. The demand curve meets the MR curve at 1000 cars for $85,000 each. The average cost at that time is $74,000. This allows Toyota to earn a higher than normal profits at the same time meeting the demand function. This situation is prevalent in the short run as other manufacturers like Ford, Hyundai launches similar models which pulls the price down until MR meets the MC curve. It moves the cost curve upwards finally resulting in the abnormal profits to be wiped off. Long Run Monopolistic Competition In the long run competitors produce cars which are similar to those of Toyota which thereby reduces the abnormal profits and since the products are substitute with slight differentiation it pushes the cost up and pulls demand down. This results in a change is equilibrium to a point where MR=MC. This is shown in the figure below Figure 2: Long Run In the long run Toyota is able to sell 935 cars as competitors launch similar products which results in certain customer to switch the product. It also reduces the price per car to $76,000 from $85,000 as Toyota to ensure customers charge them lower. This results in a situation where the MR=MC and Toyota is unable to earn abnormal profits and earns normal profit. Controversy surrounding Monopolistic Competition Monopolistic theories laid stress on the point that prices could not be jacked up in the long run and the competition would be non price competitive. This would have been true with substitute products but a look at differentiated products raise alarms. For example Germany and USA exports cars to each other specifying that they are differentiated product on certain traits. If price is not considered here then it would be difficult to consider the rising cost and prices. So, it is important that price rise be considered as an important criterion in the long run to meet the cost. (Suranovic, 2007) This is a controversy surrounding monopolistic competition and work is being carried out to gauge the efficiency of this in the long run. This is a serious consideration and considering it would make certain changes crop up in the manner monopolistic competition behaves in the market. Benefits of free trade under monopolistic competition Monopolistic Competition adds towards certain benefits which are seen in the working of Toyota. The benefits are Customer has a large number of products to choose from. This can be seen from the fact that Toyota as a brand has different cars based on price range and features. When we compare it to other cars in the same segment we see that Ford, Hyundai, Mitsubishi and others have similar cars in the same price band wagon making consumer to choose from many. The price charged is also competitive. It ensures that customers have to pay a fair price as if a company charges higher price then the competitors reduces the price therefore ensuring that the price charged is appropriate. It increases the changes of Toyota to perform in other markets as there is an ease of entry and exit. This will help the consumers as it will ensure that they get cars at the correct price. Findings The findings based on the above analysis is Toyota in the car industry performs in a monopolistic competitive environment with many sellers who have little control over prices Toyota by developing new products can earn abnormal profits in the short run as it takes time to copy a car It is difficult to earn abnormal profits in the long run as competitors and substitute products doesn’t allow the leverage to do so The controversy relating to long term price hike surrounds monopolistic competition but its effect on the long term strategy is still to be determined Recommendations Toyota should develop new cars as it will help them to earn abnormal profits at least in the short run Toyota should look forward to work in different markets as monopolistic competition provides an opportunity and this will give it a new market to develop Toyota should look towards reducing the cost and ensure that the cost curve shifts downwards as it will help them to earn higher profits. Conclusion Toyota which performs in the car industry has a monopolistic competitive market which allows earning higher than normal profits in the short run. In the long run the profits get marginalised to normal profits and firms continue operations at that point. This also throws light on the fact that Toyota can launch new variants of car ad look towards new market which will help it to earn higher profits and also be a part of the monopolistic market structure prevalent in the economy. References Keppler J, 1997, “The genesis of positive economics and the rejection of monopolistic competition theory: a methodological approach”, Cambridge Journal of Economics, Volume 22, Issue 3, page 261-276 Lin H, 1996, “Coordinating bilateral export subsidies under monopolistic competition”, Journal of International Trade and Economic Development, Volume 5, Issue 3, page 319-339 Monopolistic Competition, 2010, “Monopolistic Competition”, Amos web Michael D, Allen C, Lapham B & Beverly D, 1996, “Monopolistic Competition, increasing returns and the effects of government spending”, Journal of Money, Credit & Banking, Volume 23, Issue 4, page 45-67 Paul K, 2010, “Increasing return, monopolistic competition and international trade”, Journal of International Economics, Volume 9, Issue 4, page 469-479 Raymond D & Michael R, 1992, “Monopolistic Competition and Preference Diversity”, Journal review of Economic Studies, Volume 59, Issue 2, page 361-373 Suranovic S, 2007, “International Trade Theory and Policy”, Prentice Hall Toyota, 2010, “Toyota Australia to supply engines to ASEAN plants”, Market Watch Inc, Tokyo Read More