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Monopolistic Competition

CHAPTER. 11. Monopolistic Competition. DEFINITION OF MONOPOLISTIC COMPETITION. Definition It is a market structure in which there are large numbers of small sellers selling differentiated products. These Product are close substitute and firms have easy entry and exit from the market.

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Monopolistic Competition

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  1. CHAPTER 11 Monopolistic Competition

  2. DEFINITION OF MONOPOLISTIC COMPETITION Definition It is a market structure in which there are large numbers of small sellers selling differentiated products. These Product are close substitute and firms have easy entry and exit from the market.

  3. CHARACTERISTICS OF MONOPOLISTIC COMPETITION Characteristics • Large number of buyers and sellers: Each firm produces different or unique products, so they have some control over the prices and follows an independent price-output policy. • Differentiated products: Product differentiation could be through packaging, design, labelling, advertising and brand name.

  4. CHARACTERISTICS OF MONOPOLISTIC COMPETITION(CON’T) • Free of entry and exit into the market: Not as easy as perfect competition because of the existence of product differentiation. • Role of non-price competition is significant: Various methods used to attract the customers to buy a particular brand. • Selling cost: Different types of expenditure on advertisement would incur additional cost.

  5. (3) Total Revenue (TR) (1) Quantity (Q) (2) Price (P) 5) Profit (TR-TC) (4) Total Cost (TC) 0 1 2 3 4 5 6 7 8 9 10 200 400 560 700 800 900 1040 1200 1400 1800 2400 340 340 330 320 310 300 290 280 270 260 240 0 340 660 960 1240 1500 1740 1960 2160 2340 2400 -200 -60 100 260 440 600 700 760 760 540 0 TOTAL REVENUE – TOTAL COST APPROACH Using Table: Profit maximization is determined by scanning through the profit at each level, and the level which gives the highest profit is the profit maximizing output.

  6. TR, TC TC TR Highest vertical difference Quantity TOTAL REVENUE – TOTAL COST APPROACH (CON’T) Using Graph: TR curve is increasing and after the profit maximizing output, the curve starts to decline. Maximum profit is where the vertical difference between TR and TC is the highest.

  7. Marginal Revenue (MR) Quantity (Q) Price (P) Marginal Cost (MC) 0 1 2 3 4 5 6 7 8 9 10 200 160 140 100 100 140 160 200 400 600 340 340 330 320 310 300 290 280 270 260 240 340 320 300 280 260 240 220 200 180 60 MARGINAL REVENUE – MARGINAL COST APPROACH Using Table: The profit maximizing output level is obtained following the MR = MC rule.

  8. MR, MC MC P* AR=P MR Quantity Q* MARGINAL REVENUE – MARGINAL COST APPROACH(CON’T) Using Graph: MR curve under imperfect market is downward sloping as the output increases. The profit maximization level occurs, MR = MC, where the MC curve intersect with the MR curve.

  9. PROFIT MAXIMIZATION USINGTHE EQUATION METHOD The demand function for a monopolistic competitive firm is given as P= 2000 – 1.5Q and MC is constant at RM800 per unit. Calculate profit maximizing price and quantity.

  10. PROFIT MAXIMIZATION USINGTHE EQUATION METHOD (CON’T) Solution For profit maximization to take place, we use the MR = MC rule. Firstly, we need to derive the demand curve. Given P = 2000 − 1.5Q MR = 2000 − 3Q   MR = MC 2000 − 3Q = 800 3Q = 1200 Q = 400

  11. PROFIT MAXIMIZATION USINGTHE EQUATION METHOD (CON’T) • Substitute Q = 400 into P = 2000 − 1.5Q P = 2000 − 600 P = 1400

  12. The profit maximization level occurs where MR curve and MC curve intersect at point A. Price (RM) MC ATC To find the price, we use the same vertical line with output up to the demand curve. The profit maximizing price and output are P* and Q*. P* PROFIT AC A At output Q, the firm earns economic profit or supernormal profit equal to the area Shaded. DD = AR MR Quantity Q* PROFIT MAXIMIZATION IN THE SHORT RUN Monopolistic competitive firm economic profit Economic profit or supernormal profit is the profit earned by a monopolist when TR>TC.

  13. Price (RM) MC ATC The profit maximizing price and output are P* and Q*. A DD = AR MR Q* Quantity PROFIT MAXIMIZATION IN THE SHORT RUN (CON’T) Monopolistic competitive firm at breakeven The profit maximization level occurs where MR curve and MC curve intersect at point A. AC/P* At output, Q monopolist is at the breakeven or earns normal profit. Economic profit or supernormal profit is the profit earned by a monopolist when TR>TC.

  14. Price (RM) ATC MC AC The profit maximizing price and output are P* and Q*. LOSSES P* At output, Q monopolist suffers economic losses or subnormal profit equal to the area shaded. A DD = AR MR Quantity Q* PROFIT MAXIMIZATION IN THE SHORT RUN (CON’T) Monopoly competitive firm suffers economic losses The profit maximization level occurs where MR curve and MC curve intersect at point A. Economic losses or subnormal profit is the loss incurred by a monopolist when TR<TC.

  15. Price (RM) LRMC LRATC P* A DD = LRAR LRMR Quantity Q* PROFIT MAXIMIZATION IN THE LONG RUN Monopoly competitive firm earns normal profit in long run A monopolistic competitive firm earns normal profit in the long run due free entry and exit.

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