Monopolistic Competition

 Monopolistic competition occurs if many firms serve a market with free entry and exit, but in which one firm’s products are not perfect substitutes for the products of other firms.

 Assumptions of monopolistic competition  large number of firms  freedom of entry  differentiated product (product differentiation) ‏  Chamberlain – SELLING COST  downward-sloping demand curve Monopolistic Competition

 Selling Cost  Demand is not determined by price alone  Style, services, Selling activities  Shift in demand due to these factors  U Shaped  Product Differentiation  Real ( inherent characteristics different ) and  Fancied ( product is same ; consumer is persuaded ) ‏  Firm is NOT a price taker but the price determination is limited

Monopolistic Competition  Industry and Product Group  Industry: Same products  Product Group: Closely related products  High price and cross elasticities

Short run equilibrium of the firm Rs Q O AC MR AR  D PsPs QsQs MC

Short run equilibrium of the firm Rs Q O AC MR AR  D PsPs QsQs MC AC s

Short run equilibrium of the firm Rs Q O AC MR AR  D PsPs QsQs MC AC s

Monopolistic Competition  Assumptions of monopolistic competition  large number of firms  freedom of entry  differentiated product  downward-sloping demand curve  Equilibrium of the firm  short run  long run

Long run equilibrium of the firm Rs Q O LRAC MR L AR L  D L PLPL QLQL LRMC Qs Ps SAR SMR

Monopolistic Competition  Assumptions of monopolistic competition  large number of firms  freedom of entry  differentiated product  downward-sloping demand curve  Equilibrium of the firm  short run  long run  underutilization of capacity in long run

Excess capacity in the long run Rs Q O LRAC MR L AR L  D L PLPL QLQL LRMC a b

 Limitations of the model  imperfect information  difficulty in identifying industry demand curve  entry may not be totally free  indivisibilities  importance of non-price competition  Comparing monopolistic competition with perfect competition and monopoly  comparison with perfect competition Monopolistic Competition

 ‘Group’ Equilibrium  Product group  Technical substitutability  Economic substitutability  Within group each firm has its own demand curve  Slight product differentiation

Long run equilibrium of the firm Rs Q O P1P1 LRAC D L under perfect competition Q1Q1

Long run equilibrium of the firm perfect and monopolistic competition Rs Q O P2P2 P1P1 LRAC D L under perfect competition D L under monopolistic competition Q2Q2 Q1Q1

Identifying Monopolistic Competition  Two indexes:  The four-firm concentration ratio  The Herfindahl-Hirschman Index

The four-firm concentration ratio  The percentage of the value of sales accounted for by the four largest firms in the industry.  The range of concentration ratio is from almost zero for perfect competition to 100 percent for monopoly. oA ratio that exceeds 40 percent: indication of oligopoly. oA ratio of less than 40 percent: indication of monopolistic competition.

The Herfindahl-Hirschman Index (HHI) ‏  The square of the percentage market share of each firm summed over the largest 50 firms in a market.  Example, four firms with market shares as 50 percent, 25 percent, 15 percent, and 10 percent.  HHI = = 3,450  A market with an HHI less than 1,000 is regarded as competitive.  An HHI between 1,000 and 1,800 is moderately competitive.

 Limitations of Concentration Measures  The two main limitations of concentration measures alone as determinants of market structure are their failure to take proper account of oThe geographical scope of a market oBarriers to entry and firm turnover

 Thank you…………………..