Differences between Monopolistic Competition and Monopoly - Essay Example

Differences between Monopolistic Competition And Monopoly Monopoly and Monopolistic Competition are two of the many kinds of Imperfect Competition. According to Nordhaus and Samuelson, “If a firm can appreciably affect the market price of its output, the firm is classified as an “imperfect competitor” (NORDHAUS, Willain D. and Samuelson, Paul A., 1998). It means that an imperfect firm has a control over the market price. This control varies from industry to industry. Monopoly is the extreme condition of imperfect competition. It is just the opposite of Perfect competition. In a Monopoly, there is a single seller with considerable control over the market. The word, “Monopolist” is derived from the Greek words, Mono meaning one and Polist for seller (FRIEDMAN, Milton, 2002). The existence of Monopoly in today’s world is very rare. Monopolies are usually protected by effective barriers to entry. Example of Monopolies may be a company with its unique patented drug or the only provider of electricity for a town. De Beers used to have Monopoly in the diamond market. Monopoly does not have a complete control over price in a sense that it faces a negatively sloped demand curve. This means, any price increase will eventually loss some customers. Keeping in view, a Monopoly always wants to maximize its profit. For maximizing the profit, a Monopoly increases its output to the level where Marginal Cost (MC) intersects the Marginal Revenue (MR) as shown in the figure 1. The diagram shows the profit maximization point for a monopolist. The profit maximization point lies where Marginal Revenue = Marginal Cost. The economic profit is the difference between the Demand and ATC curve. If it produces less than 5 units, the economic profit will be reduced. Also, if the output is increased to 6, the economic profit will again reduce. A Monopolist will always strive for maximizing its profit. For a Monopolist, the Demand Curve is negatively slopped. If the demand for the product is less elastic, a Monopolist can fix a higher price. Ineleastic goods include those which are needs of human being such as electricity, sugar, wheat etc. However, if the demand is elastic, then a Monopolist should adjust the price to a certain level to gain maximum profit. Therefore, the price it charges is always greater than its MC. In Monopolistic competition, there are many competing firms which are selling differentiated products (Investopedia.com). Due to this fact, each firm faces highly elastic negatively sloped demand curve. The term “Differentiated Product” refers to those products which are substitute but are different in important characteristics. The important characteristics of differentiated products vary. For example, for mobile phone, important characteristics include performance, quality, functions, multimedia, advertisement and packaging etc. Monopolistic Competition is closer to Perfect Competition rather than Monopoly. The only difference between a Monopolistic Competition and a Perfect Competition is that a Monopolistic Competition sells differentiated product. In the short run, profit maximizing point of Monopolistically Competitive firm is same as a Monoplistic firm. Both of these faces downward sloping demand curve and profit maximizing is MR = MC. In short-run, Price > ATC, thus, economic profit is made. However, in the long-run, due to the excess of profit, new firms enters the market and Demand curve for existing firms shifts left and might also become more elastic. This might result in zero-profit equilibrium. The Demand Curve (D) becomes tangent to Average Total Cost Curve (ATC) as shown in the diagram. Monopoly Monopolistic Competition 1. Only single seller of the commodity. Therefore, the firm and the industry are same. 1. There are many sellers with differentiated commodity. Therefore, no one has absolute or full control over the market. 2. High barriers to entry. It is hard to be a Monopoly. There are numerous barriers toward it. These barriers can be classified into three groups – Economic, Legal and Deliberate barrier. Economic Barriers includes economies of scale 2. On the other hand, Monopolistic competition faces very few barriers to entry. Unlike Monopoly, it faces no serious barriers. 3. Demand is Relatively inelastic 3. Demand is Highly elastic (AYERS, R and Colling, R, 2003) 4. Product differentiation is absolute 4. Product differentiation is high 5. There is excess profit 5. No excess profit (PINDYCK, R and Rubinfeld, D, 2001) 6. Profit maximizing condition is MR = MC 6. Profit maximizing condition is MR = MC Interest of Consumers Monopoly can restrict the output and raises price and vice versa. This is very harmful for buyers. For example, the sole provider of a Cancer drug, if wants to increase the price, may reduce the output. As being the sole seller of a commodity, a Monopoly may concentrate the output for acquiring personal benefits, which is against the spirit of equality in the society. In a competitive environment, firms strive to provide better goods and services to the buyers to maintain or gain the market share. In this manner, the consumer is eventually benefited. While, a Monopoly is free from these threats, therefore, it may not properly serve its customer. They indulge in price discrimination. Monopolies may also engage in predatory pricing to drive its competitors off. On the other hand, Monopolistic Competitive market structure involves competition and competition among firms is beneficial for the consumers. Since, all the firms can contribute only a small portion in price making, Monopolistically Competitive firms do not indulge in anti-consumer behaviors like Monopoly do. Due to competition, every firm strives to provide the quality product or service to its customer. In order to gain market share, monopolistic firms focus on inventing new methods of product or new products. The invention of production methods may help reduce cost, which will eventually be advantageous for the society. It paves the way of thinking for new products. It increases the variety of products in the market. However, those products by Monopolistically Competitive firms which are differentiated through various advertising or packaging do not provide any benefit to the society. From the above discussing, it is clear that the benefits of Monopolistically Competitive Market are far beyond than that of a Monopolistic Competition. References AYERS, R and R COLLING. 2003. Microeconomics page 280. Pearson. FRIEDMAN, Milton. 2002. Monopoly and the Social Responsibility of Business and Labor. The University of Chicago Press. Investopedia.com. [online]. [Accessed 19 November 2009]. Available from World Wide Web: < HYPERLINK "http://www.investopedia.com/terms/m/monopolisticmarket.asp" http://www.investopedia.com/terms/m/monopolisticmarket.asp > NORDHAUS, Willain D. and Paul A. SAMUELSON. 1998. Economics. Irwin McGraw-Hill. PINDYCK, R and D RUBINFELD. 2001. Microeconomics. Prentice-Hall. Read More