Monopolistic Competition and Monopoly Market Structure - Essay Example

Running head: Monopolistic competition and monopoly market structure. Among the market structures, monopolistically competitive markets are common. These markets consist of numerous producers. The producers have their goods or products differentiated (Stephen & Stuart, 2007). Goods sold in this market are assumed to have no difference in their prices. Any price difference in monopolistic competition market is not great to make the goods to be substituted for other cheap goods (Stephen & Stuart, 2007). Under monopolistic competition there are many sellers in the market selling one similar product. For this matter, the producers or the sellers have the freedom to determine the price of their goods without making strategic decision (Stephen & Stuart, 2007). s Firms or producers in monopolistic competition market structure have the freedom to enter and exit the market. In this market structure, there are many firms willing to enter the market either to bring unique product to the market, or to enjoy positive profit. If a firm is not able to pay for its costs can exit the market without undergoing liquidation costs (Stephen & Stuart, 2007). However, the monopolistically competitive markets have got some market power. A monopolistic seller can increase the product price and fail to loss all his or her buyers (Stephen & Stuart, 2007). A reduction in price by a monopolistic seller may not lead to a serious price war with the other competitors. In this nature of market, there is perfect information of the market. Buyers are much aware of the goods sold in the market (Roger, 2001). Regarding the decision making process in monopolistic competition market structure, producers are independent in setting the exchange terms for their products. The firms do not consider the ultimate effects of their decision to the rest of competitors (Roger, 2001). The firms make decisions on the assumption that their effect to the overall market is negligible and, they can not alter the market demand (Roger, 2001). On the other hand, a monopoly market structure is where we have only one seller or producer. In this case the firm is also the industry (Roger, 2001). There are restrictions of entry to monopoly market because of high costs. Other factors that may put barriers to this market could be: social, political, or economic factors (Roger, 2001). Monopoly exercises capitalism in the market. It has been said that many systems fail to work when they have only one provider of products as they lack incentives to produce or sell products which satisfy the consumer needs. Also, when a firm is given patent rights due to its innovation of a particular product, it will result to monopoly in the market (Roger, 2001). The patent rights are given to innovators so as to recover the costs they incurred in research and development of the new idea. However, after some time when they are thought to have recovered all the cost, the innovators lose the patent rights (Roger, 2001). Government may create monopoly in the market so as to offer essential services to the people (Roger, 2001). Under monopoly market structure, producers have power to influence their prices. In this case, the sellers are said to be price setters rather than price takers (Stephen & Stuart, 2007). Although a monopoly may increase the price of its products, there will be a decline of sales. If a monopoly increases the number of sales, more revenue will be gained since it is the only seller of that particular product. If a monopoly lowers the price, less revenue will be gained as the units sold fetch less money (Stephen & Stuart, 2007). The above market structures affect the welfare of consumers and producers in terms of consumer surplus and producer surplus. Under the monopolistic competition market, the efficient allocation of resources may result to consumer surplus which has a positive effect on the welfare of the consumers (Stephen & Stuart, 2007). The monopolistic competition market goods and services are produced by utilizing the scarce resources optimally so as to meet the needs of consumers. The prices of these products are set in a fair manner that reflects the value of resources that were used in the production process (Stephen & Stuart, 2007). The following diagram shows the welfare effect of monopolistic competition market in the short run. Areas abP1 and aP1c on the diagram above show the consumer surplus and producer surplus respectively. Due to efficient allocation of scarce resource by monopolistic competition market Q1 and P1 are the optimal quantity and price respectively. The consumer welfare is positively affected, as the consumers are spending less than they were willing to spend. In this case, the consumers can use the excess money to cater for other needs. Increase of price above the equilibrium price by one firm in monopolistic competition can lead to loss of consumer and producer welfare. However, since the buyers have information on the market they will shift to cheaper products from other sellers and thus the equilibrium price will have to prevail in the market. On the other hand, the monopoly has negative effect on the welfare of the consumers. In this market, the consumer surplus turns to be the revenue of the monopoly (Roger, 2001). Due to the power of pricing the monopoly sets the price at a level of its interest irrespective of the production cost. Monopolies have the ability to exercise price discrimination to different consumers. As result of price discrimination and setting of prices at higher levels, there will be a welfare transfer from the consumers to the producers (Kalman & Chard, 1975). The following diagram shows the consumer welfare transfer to producers in a monopoly market. From the diagram above area adP1 shows the consumer surplus. The producer in this case has the power to increase price from point a, which is the equilibrium price, to point d along the monopoly demand curve. The power to increase price and to exercise price discrimination by the monopoly turn the consumer surplus into additional producer revenue. This will have a negative effect on consumers as their welfare is affected by the increase in price. To sum up, the two market structures differ in that, monopolistic competition market structure has many firms while monopoly has single seller. There is free entry for new entrant in monopolistic competition market where as in monopoly entry is restricted. The monopoly has got more power in price control unlike the monopolistic which has less power to control price in the market. Decision to increase price under the monopoly has strong effect on the consumers unlike in monopolistic competition market. It’s this factor that makes the monopolistic competition market to serve the interests of consumers, as it does not interfere with their welfare. References: Kalman, J. & Chard, M. 1975, Theory of the firm: resource allocation in a market economy, Unites States; Prentice-Hall. Roger, A. 2001, Microeconomics, Cincinnati, Ohio; South-Western College Pub, Stephen, I. & Stuart, W. 2007, Economics, London; Financial Times Prentice Hall. Read More