The demand curve of monopolistic competition is downward sloping from left to right. The slope of the curve indicates that as the prices of goods and services decrease the demand for these products increases. The slider has some implications in the monopolistic competition market. The reason for the shape of the demand curve is because the market does not influence the price of the product this implies that to some degree the firms are price takers, not price takers. (SDhingra 2012) Besides, there is less competition due to product differentiation unlike in a perfect competition market where there are excellent substitutes. By differentiating its products firms creates a situation where there are imperfect substitutes, and a company that works well on its products will attract the price they want without risking the number of customers they have.
Monopolistic markets maximize their profits when they produce at a level where the marginal cost is equal to marginal revenue. The downward sloping curve reflects the market power and the prices that the firm's charge will exceed the minimal cost. In this type of market, the suppliers will have excess production.
In the short run, the monopolistic market will experience profits but are inefficient. A short sequence refers to a period where one factor of production is fixed, while others are variable. The market will maximize its profits when the marginal revenue is equal to the minimal cost. The price and output determination is as illustrated by the curve below.
In the long run, this market is highly inefficient, and it can only break even. In the long term, all the factors of production are variable, and they can be adjusted to counter the shifts in demand. The firm will not gain make an economic profit but only break even. Because of the extended period that a company has to vary its factors of production, it can enter and exit an industry expand and reduce its capacity to produce. The illustration below explains the concept of price determination under the long run.
Efficiency in a monopolistic competition
In this type of market, there is no efficiently in an economic sense because goods are always priced higher than the marginal cost. The market will never achieve the productive efficiency and suppliers will under produce that is below their capacity. Consumer surplus is less because prices are set to be higher than the marginal cost. The consequence is experiencing a reduced economic surplus and deadweight loss SDhingra 2012). In this regard, consumer surplus refers to the most senior price the consumer the consumer can pay and the actual amount that they pay. On the other hand, the producer surplus refers to the market price that suppliers sell their products higher than the low price they would have otherwise sold.
There are two types of efficiencies namely productive and allocative ability. The productive energy is where the market is using all its resources competently. While allocative occurs when the market is producing goods to maximize the social welfare (SDhingra 2012). It is important to note that in a monopolistic competition the firm set the prices of the products to be higher than the marginal cost and they, therefore, can never achieve the productive efficiency. Besides they do not attain the allocative productivity because of how the prices are set.
In a perfect competition market, the demand is elastic, and there are a variety of substitutes in the market. Price control is hard because the forces of demand and supply play a significant role in determining the prices. When the goods being sold are improved or changed in a little way, then the prices of products in the market can be controlled. When the two markets the monopolistic and perfect competition are compared the ideal market becomes the price taker because it is not able to determine its prices, but instead the interaction of the forces of demand play this critical role. (SDhingra 2012)The market has a lot of substitutes, and therefore no one particular firm can influence the prices of the good or a service because no product is different from another a customer can buy a product from any outlet with the same amount. It is therefore referred to as the price taker.
On the other hand, the monopolistic competition is referred to as a price maker.In this market, a firm takes the price of another and ignores its own. There are no perfect substitutes, and therefore elasticity of demand is low. The products are differentiated, and the highest price possible can be fetched by a firm correctly separating its products and making them more appealing to the consumer(Bertoletti, & Etro 2017).. The most senior price can be brought without interfering with the customer base. It is the only way to which the prices of goods and service as can be controlled. The best package of differentiation achieves the highest rates the distinction can be based on quality branding, packaging among others. As much as it seems impossible to determine the prices effectively, the differentiating factor plays a significant role in achieving the desired costs
It is worth noting that monopolistic competition concerns product differentiation as the primary characteristic. Product differentiation refers to the practice of distinguishing a product or a service to make it more appealing than others with the aim of attracting potential customers or the target market. Firms practice product differentiation to make their products look conspicuous when compared to that of a competitor. The facet of distinction was developed by Edward Chamberlin under the theory of monopolistic competition. Firms have different resource allocation, and each one may be peculiar to affirm which makes it have a competitive advantage over others (Nocco, 2014)s. Resource possession enables businesses to have their products distinguished, and this aspect slows down competition in the market because though products may serve a given function, they are different from that of another firm. Also, simple distinction where products are distinguished based on multiple traits and the horizontal where differentiation is based on a single feature but the consumers are not conversant to the quality of the product. The primary goal of product differentiation is to establish a market share or position which the consumers can recognize and familiarize. Differentiation reduces the magnitude of competition in firms. Product differentiation enables businesses to reach out to new segments of the market. When a product is successfully differentiated, it leads to competitive advantage and is changeable with the factors of perfect competition which is pegged to perfect substitutes. There is three categories of product differentiation namely vertical differentiation where products are differentiated based on one characteristic, and the consumers are well versed with the quality.
Zhelobodko, E., Kokovin, S., Parenti, M., & Thisse, J. F. (2012). Monopolistic competition: Beyond the constant elasticity of substitution. Econometrica, 80(6), 2765-2784.
Nikaido, H. (2015). Monopolistic Competition and Effective Demand.(PSME-6). Princeton University Press.
Dhingra, S., & Morrow, J. (2012). Monopolistic competition and optimum product diversity under firm heterogeneity. London School of Economics, mimeograph.
Bertoletti, P., & Etro, F. (2017). Monopolistic competition when income matters. The Economic Journal, 127(603), 1217-1243.
Nocco, A., Ottaviano, G. I., & Salto, M. (2014). Monopolistic competition and optimum product selection. The American Economic Review, 104(5), 304-309.
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