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TOPIC 5-Monopolistic Competition (A)

The document discusses monopolistic competition as one of the four main market structures, highlighting its characteristics such as product differentiation and strategic behavior. It explains the concepts of horizontal and vertical differentiation, approaches to consumer preferences, and equilibrium solutions in the market. Additionally, it addresses the implications of monopolistic competition on pricing, economic efficiency, and long-run outcomes for firms.

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2 views

TOPIC 5-Monopolistic Competition (A)

The document discusses monopolistic competition as one of the four main market structures, highlighting its characteristics such as product differentiation and strategic behavior. It explains the concepts of horizontal and vertical differentiation, approaches to consumer preferences, and equilibrium solutions in the market. Additionally, it addresses the implications of monopolistic competition on pricing, economic efficiency, and long-run outcomes for firms.

Uploaded by

Arthur
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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ECN 9125-Industrial Organization

Topic 4: Monopolistic
Competition (A)
(Market Structure 1)
Mr. Chizonde, B.
Department of Economics
University of Zambia
©2017
Outline
• 1. Introduction to Market
Structures
• 2. Product differentiation
• 3. Approaches to Preferences
• 4. Equilibrium solutions
1. Introduction to Market Structures
• There are basically Four (4) Main market
structures. These are:
• (a) Perfect Competition
• (b) Pure Monopoly
• (c) Monopolistic Competition
• (d) Oligopoly
• Let us consider their main characteristics.
1. Introduction to Market Structures
• A: Perfect Competition
• Many sellers of homogenous product
• Price-taking behavior and Free-entry and exit
• Key Concept: Efficiency
• Example: Chicken producer in Zambia
• B: Pure Monopoly
• A single seller of unique product
• Price-making behavior and no-entry or exit
• Example: Electricity supply in Zambia
• Key concept: Price discrimination
1. Introduction to Market Structures
• C: Monopolistic competition
• A lot of sellers of differentiable product
• Strategic behavior and easy entry and exit
• Key concepts: Product differentiation and
advertisement
• Example: Phone producers in the world
• D: Oligopoly
• Few large sellers of homogenous product
• Strategic behavior and entry is hard
• Key concept: Advertisement
• Example: Telecommunications in Zambia
(Market Structure 1)
Monopolistic Competition
2. Product differentiation
• 1. What is product differentiation?
• There are two types of product differentiation:
• (a) Products are horizontally differentiated if
consumers have heterogeneous (different)
preferences regarding which product is the best.
• This is termed preference based differentiation.
• It occurs when products are close substitutes and
prices are almost identical.
• Example: Coke and Pepsi
2. Product differentiation
• (b) Products are vertically differentiated if
consumers unanimously agree on which
product is preferred.
• If all products had the same prices, consumers
would all purchase the same product.
• They agree on a quality index and this type of
product differentiation is quality based.
• Example: Phones (High grade and low grade)
3. Approaches to Preferences
• There are two common approaches to modeling
consumer preferences when products are horizontally
differentiated:
• (a) Address approach: Assumes that consumers have
preferences over the characteristics of products (You
buy cause you like its characteristics)
• (b) Goods approach: Assumes that consumers have
preferences over goods and tastes for variety. (You buy
because you like the characteristics or because you just
want to change)
3. Approaches to Preferences
• Monopolistic competition uses the goods approach to
modeling preferences over horizontally differentiated
products.
• This approach assumes the following:
• (a) A large set of differentiable products over which
preferences are defined (products are imperfect
substitutes)
• (b) Preferences are symmetric (products are close
substitutes)
• (c) Preferences can be aggregated and represented by a
single ‘representative consumer’
• (d) Technology is characterized by economies of scale.
4. Equilibrium solutions
• The Demand Curve
• The firm’s demand curve is highly elastic, but
not perfectly elastic.
• It is more elastic than the monopoly’s demand
curve because the seller has many rivals
producing close substitutes; it is less elastic
than pure competition, because the seller’s
product is differentiated from its rivals.
4. Equilibrium solutions
• Maximization Condition (short-run)
• The MR = MC rule will give the firms the profit –
maximizing output. The price they charge would
be on the demand curve.
• In the long run, the situation will tend to be
breaking even for firms. Firms can enter the
industry easily and will if the existing firms are
making an economic profit.
• If the demand shifts below the break-even point,
some firms will leave the industry in the long run.
4. Equilibrium solutions
• Long-run Equilibrium
• Therefore, most monopolistic competitive firms
should experience break-even in the long run
theoretically.
• In reality, some firms experience profit as they
are able to distinguish themselves from the
others and build a loyal customer base.
• Some firms experience loses in long run but may
continue the business as they are still earning
normal profit.
4. Equilibrium solutions
• Social Outcomes
Pmc  MC mc
AC mc  AC pc

• Price exceeds marginal cost in the long run,


suggesting that society values additional units
which are not being produced.
• Average costs may also be higher than under
perfect competition, due to advertising cost
involved to attract customers from competitors.
4. Equilibrium solutions
• The various types, styles, brands and quality
of products offers consumers choices.
However, economic inefficiency is the result.
Q S  MES

• The excess capacity (producing at the


quantity that a firm produces is less than the
quantity at which ATC is a minimum) exists in
this industry.
Review Question
• Two firms are producing closely related but
differentiable products. The demand curves for
these products are given as:
p1  30  2q1
p2  40  2.5q2
• 1. Find the short-run equilibrium price and
quantity for each firm given that:
AC 1  5
• . AC 2  6
Review Question
• suppose that If the two firms no longer
differentiate the goods the following demand
function would be faced by both firms:
• p  3410q
• Which firm would earn higher profits?
• Will the firms continue earning these profits in
the long-run?

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