1 How does monopolistic competition differ from pure competition in its basic ch
ID: 1251364 • Letter: 1
Question
1 How does monopolistic competition differ from pure competition in its basic characteristics? From pure monopoly? Explain fully what product differentiation may involve. Explain how the entry of firms into its industry affects the demand curve facing a monopolistic competitor and how that, in turn, affects its economic profit.2 "Competition in quality and in service may be just as effective as price competition in giving buyers more for their money." Do you agree? Why? Explain why monopolistically competitive firms frequently prefer nonprice to price competition.
3 Critically evaluate and explain:
a. In monopolistically competitive industries, economic profits are competed away in the long run; hence, there is no valid reason to criticize the performance and efficiency of such industries.
b. In the long run, monopolistic competition leads to a monopolistic price but not to monopolistic profits.
Explanation / Answer
1. In monopolistic competition there are many firms but not the very large numbers of pure competition. The products are differentiated, not standardized. There is some control over price in a narrow range, whereas the purely competitive firm has none. There is relatively easy entry; in pure competition, entry is completely without barriers. In monopolistic competition, there is much nonprice competition, such as advertising, trademarks, and brand names. In pure competition, there is no nonprice competition. In pure monopoly there is only one firm. Its product is unique and there are no close substitutes. The firm has much control over price, being a price maker. Entry to its industry is blocked. Its advertising is mostly for public relations. Product differentiation may well only be in the eye of the beholder, but that is all the monopolistic competitor needs to gain an advantage in the market—provided, of course, the consumer looks upon the assumed difference favorably. The real differences can be in quality, in services, in location, or even in promotion and packaging, which brings us back to where we started: possibly nonexistent differences. To the extent that product differentiation exists in fact or in the mind of the consumer, monopolistic competitors have some limited control over price, for they have built up some loyalty to their brand. When economic profits are present, additional rivals will be attracted to the industry because entry is relative easy. As new firms enter, the demand curve faced by the typical firm will shift to the left (fall). Because of this, each firm has a smaller share of total demand and now faces a larger number of close-substitute products. This decline firm’s demand reduces its economic profit. 2. This can certainly be true. It depends on how much consumers value quality and service, and are willing to pay for it through higher product prices. In a monopolistically competitive market the consumer can buy a substitute brand for a lower price, if the consumer prefers a lower price to better quality and service. The monopolistically competitive firm frequently prefers nonprice competition to price competition, because the latter can lead to the firm producing where P = ATC and thus making no economic profit or, worse, producing in the short run where P minimum ATC, productive efficiency is not attained. The firm is producing too little at too high a cost; it is wasting some of its productive capacity. With P > MC, the firm is not allocating resources in accordance with society’s desires; the value society sets on the product (P) is greater than the cost of producing the last item (MC). (b) The statement is often true, since competition of close substitutes tends to compete price of the average firm down to equality with ATC. Thus, there is no economic profit. However, the firm is producing where its (moderately) monopolistically downward-sloping demand curve is tangent to the ATC curve, short of the point of minimum ATC and thus at a higher than purely competitive price. In other words, it is at a “monopolistic” price.Related Questions
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