LESSON 7 PERFECT COMPETITION & MONOPOLISTIC COMPETITION

Perfect competition In economic theory, perfect competition (sometimes called pure competition) describes markets such that no participants are large enough to have themarket power to set the price of a homogeneous product. Because the conditions for perfect competition are strict, there are few if any perfectly competitive markets.economic theorymarket powerhomogeneous product

Perfectly competitive markets are not productively efficient as output will not occur where marginal cost is equal to average cost (MC = AC). They are allocatively efficient, as output will always occur where marginal cost is equal to marginal revenue (MC = MR). In the long run, perfectly competitive markets are not allocatively and productively efficient because it is essentially "sweatshop" economics and limits the growth and productivity of the firm.productively efficientallocatively efficient

In perfect competition, any profit-maximizing producer faces a market price equal to its marginal cost (P = MC). This implies that a factor's price equals the factor's marginal revenue product. It allows for derivation of the supply curve on which the neoclassical approach is based. This is also the reason why "a monopoly does not have a supply curve". The abandonment of price taking creates considerable difficulties for the demonstration of a general equilibrium except under other, very specific conditions such as that of monopolistic competition.market priceneoclassical approachmonopolistic competition

An example is that of a large action of identical goods with all potential buyers and sellers present. By design, a stock exchange resembles this, not as a complete description (for no markets may satisfy all requirements of the model) but as an approximation. The flaw in considering the stock exchange as an example of Perfect Competition is the fact that large institutional investors (e.g. investment banks) may solely influence the market price. This, of course, violates the condition that "no one seller can influence market price".stock exchange

Equilibrium in perfect competition is the point where market demands will be equal to market supply. A firm's price will be determined at this point. In the short run, equilibrium will be affected by demand. In the long run, both demand and supply of a product will affect the equilibrium in perfect competition. A firm will receive only normal profit in the long run at the equilibrium point.

Monopolistic competition Monopolistic competition is a type of imperfect competition such that many producers sell products that are differentiated from one another (e.g. by branding or quality) and hence are not perfect substitutes. In monopolistic competition, a firm takes the prices charged by its rivals as given and ignores the impact of its own prices on the prices of other firms.imperfect competitiondifferentiatedsubstitutes

In the presence of coercive government, monopolistic competition will fall intogovernment-granted monopoly. Unlike perfect competition, the firm maintains spare capacity. Models of monopolistic competition are often used to model industries.government-granted monopolyperfect competition

There are six characteristics of monopolistic competition (MC): Product differentiation Many firms No entry and exit cost in the long run Independent decision making Same degree of market power Buyers and Sellers do not have perfect information (Imperfect Information)

A monopolistically competitive firm might be said to be marginally inefficient because the firm produces at an output where average total cost is not a minimum. A monopolistically competitive market is productively inefficient market structure because marginal cost is less than price in the long run. Monopolistically competitive markets are also allocatively inefficient, as the price given is higher than Marginal cost.

Another concern is that monopolistic competition fosters advertising and the creation of brand names. Advertising induces customers into spending more on products because of the name associated with them rather than because of rational factors. Defenders of advertising dispute this, arguing that brand names can represent a guarantee of quality and that advertising helps reduce the cost to consumers of weighing the tradeoffs of numerous competing brands.advertisingbrand names