Perfect vs Monopolistic Competition in Keynesian Model - Essay Example

The consumers and sellers have perfect information of the product price prevailing in the market. And, all firms in a perfectly competitive market aim to maximize profit. The sellers have an ‘insignificant’ market share in a perfectly competitive market, implying that each firm is acting as a price-taker. Monopolistic competition, on the other hand, has as many producers and consumers as the perfect competition. Producers enjoy a degree of control over price. The products sold and purchased in a perfectly competitive market are homogeneous, which are perfect substitutes for each other. In contrast, the products sold in the monopolistically competitive market are heterogeneous. In other words, when a large number of buyers and sellers interact to buy and sell heterogeneous products we have monopolistic competition. Thus, a monopolistically competitive market differs from a perfectly competitive market mostly because of product differentiation, i.e. products are not perfect substitutes. The monopolistic competition involves many aspects of non-price competition.

In perfect competition, the long-run market equilibrium is determined where, Marginal Revenue (MR) = Marginal Cost (MC) = Price (P) =Average Revenue (AR) = Average Cost (AC). In the short run, new firms enter the market, in case the existing firms are making supernormal profits, thereby making reallocation of resources within the market. Given demand remains unchanged, the increased output (with new firms entering the market) shifts the aggregate supply curve to the right and drives the equilibrium market price down until price equates to long-run average cost. Thus, long-run equilibrium is established as firms have no incentives now to move in or out of the market. Hence, in the long-run firms make normal profits.

In perfect competition ‘allocative efficiency’ is achieved, both in the short-run and long-run, since price equates to marginal cost. Production efficiency, occurring when the price is equal to average cost at its minimum, is, however, achieved only in the long run. Combining the two, it can be said in the long-run optimal levels of ‘static economic efficiency’ are reached in perfect competition.

In monopolistic competition, the long-run equilibrium is determined at, MR = MC <P = AR= AC. A monopolistically competitive market thus is not efficient in resource allocation, compared to a perfectly competitive market.