Monopolistic Competitive Markets - Term Paper Example

Monopolistic Competitive Markets Competition in microeconomics can be broadly categorized into two i.e. Perfect Competition and Imperfect Competition. Perfect competition denotes a market structure that has strong assumptions that they are unlikely to be applicable in the real – world market situations and imperfect competition is a type of competition existing in a market and does not fulfill the requirements necessary for a perfect competition Some of these assumptions include the assumption that there exist many small firms in the market each producing a small portion of the total output produced by the market. Another assumption is the absence of a monopsony situation i.e. The buyers are many and none of them has any control over the market. The third assumption is that the entry and exit to and from the industry is feasible and no sunk costs are incurred by firms in doing this, thus going by this assumption there is the assurance that all firms will be profitable in the long run. The fourth assumption is that consumers are fully informed about the prices and products that the completion has and can easily gain access to this information. The final assumption regards to external players entering the market and it assumes that there is no entry of new players in the existing market. These assumptions are clearly not applicable to any real –world situation and it is from this reason that many real – world markets are categorized under imperfect competition which is a type of competition existing in a market which does not fulfill the requirements necessary for a perfect competition. There are several types of imperfect competition namely: monopolistic competition, monopoly, oligopoly, monopsony, oligopsony and finally information asymmetry. In this essay I am going to take a deeper look at monopolistic competition, its features and how it impacts the industry as a whole. Monopolistic competition is a form of imperfect competition that involves many competing retailers, producers or suppliers selling products that have been differentiated from one another (William 2011). The products are actually substitute products but because of the differentiation activities that they have undergone such as different branding, they are not exactly the same. Firms in a monopolistic competition can have characteristics of a monopoly in the short run e.g. exploiting their market dominance to obtain abnormal profits but in the long run other firms enter the market thus increasing the market’s competition. In many cases, a firm in a monopolistic market will break even in the long run this is due to the fact that the major factor affecting this kind of competition is not the price but product differentiation, therefore a firm that is in a monopolistic market has a downward sloping demand curve unlike the a demand curve for a firm in a perfectly competitive market which is perfectly elastic. There are some market characteristics that will make a market to be categorized as a monopolistic competition. One of the key characteristics of a monopolistic competition is product differentiation. Firms in a monopolistic competition sell goods that have non – price differences but theses differences are not so high that they can eliminate substitute goods therefore the demand elasticity between these goods is always positive (Cochran 1990). The goods are close but imperfect substitutes implying that these can perform the same function but for one reason or the other they are not easily substituted or one another e. g. a motor cycle and an SUV do basically the same thing that is to transport people from one point to another but a motor cycle cannot be a substitute for an SUV. `Another characteristic of a monopolistic competition is the existence of many firms within a given product group and also many firms potential firms that are prepared to enter into the market. The phrase “a product group” refers to a group of many similar product items. The existence of many firms’ means that an individual firm within the market can set prices with disregard to the prices of other firms therefore the actions of a single firm has negligible impact on this market. For instance, a firm might decide to take such drastic measures as cutting prices without any concerns of corresponding responses from its competitors. The number of firms that can be supported by a single market at equilibrium depends on several factors including fixed costs for operating a firm, economies of scale involved in running the firms and the degree of differentiation between the products. For instance if the value of fixed cost is high then few firms will be supported by the market. Free entry and exit is another characteristic that is associated with a monopolistic economy. There are always firms on the sidelines waiting to enter the market each expecting to make profits with its own product and they can do so easily. In case a firm wants to exit the market it can do so without it having to incur ant liquidation costs. Thus this implies that the start up costs is low, there are no sunk costs and there are no costs associated with exiting the market. Monopolistic competition is also characterized by independent decision making by the firms that are within the market. A firm in monopolistic market has the freedom to set prices for its products without having to worry about how its actions will impact on its competitors (Cochran 1990). Theoretically it is assumed that a single firm’s activities have negligible effect on the whole market demand. In essence each firm has some degree of monopolistic advantages as it enjoys some of the freedoms that are enjoyed by monopolies. Firms in a monopolistic competitive market also enjoy to some extent the advantage of possessing market power. By market power I mean that theses firms have some degree of control over the terms and conditions with which they exchange. For instance, a firm can decide to raise its prices without it losing most of its customers. It can also decide to lower the price of its commodities and this will not result in a price war between it and its customers. Unlike firms in other markets, a firm in a monopolistic competition does not derive its power by barring others from entering the market but it derives power due to the fact that it does not face a lot of competition from other firms and thus and these other firms due not make decisions strategically intended to affect its activities. Furthermore firms in a monopolistic competition sell products that are differentiated hence they do not need to worry about substitute products. Due to market power, affirm in a monopolistic competition has a downward sloping demand curve which is elastic. Another aspect of a monopolistic competition is the unreliability of the available information. Due to the high number of firms in the market and the absence of strategic decision making by firms in a monopolistic competition, there is usually inadequate information available to the sellers or buyers concerning the prevailing market conditions. Such information might be with regard to market demand or the level of supply in the market. These might be a shortcoming to the buyers or the sellers who might not be able to make informed decisions regarding what action to take given the present or past set of circumstances as they will not have enough information about a given situation. A monopolistic market is also faced with the problem of inefficiency. Inefficiency in a monopolistic market is caused by two aspects. The first cause for inefficiency in a monopolistic competitive market structure arises from the fact that, the firm usually charges a price which exceeds its marginal cost when it is operating at its optimum output. In order for the firm to maximize profits, the marginal costs should be equal to marginal revenue and since the marginal cost demand curve or the firm has a downward slope then this implies that the price that the firm will be charging will be more than the marginal costs (Cochran 1990). Thus due to the monopoly power that firms possess in a monopolistic competition at a firm’s level of production that is profit maximizing, the firm will experience a net loss of consumer and producer surpluses. The other cause of inefficiency among firms in a monopolistic competition arises fro the fact that these firms operate under excess capacity. This means that firm’s output that maximizes profits is less than that which affects minimum average costs. The firm will operate at a level where price is equal to average costs. Due to the nature of the demand curve for a firm in this market that is downward sloping, the demand curve will the demand curve will have to be at a tangent to the average cost one in the long run thus resulting in excess capacity. A monopolistic market competition due to its very nature of being an imperfect form of competition and just like any other imperfect competition has its fair share of problems but I believe its strong points are more than its weaknesses and for this reason I think it is a good system of market competition. Work Cited Socow, R. Monopolistic Competition: Technical progress and income distribution, New York: Garland Publishers, 1996.Print. Cochran, L. Monopolistic Competition and mMicroeconomics, London: Macmillan Publishers, 1998.Print. McEachern, William. Economics: a contemporary introduction, New York: Cengage Leaarning, 2011.Print. McEachern, William. Monopolistic Competition: a stable market structure? New York: Cengage Leaarning, 2011.Print. Cochran, L. Equilibrium and Optimlity, London: Machmillan Publishers, 1990. Print. Read More