Friday, July 26, 2013

Microeconomics (2066Q2): What is monopolistic competition? How price and output is determined under it in the long run? In what respect it is different under perfect competition?

Monopolistic Competition

It refers to a market structure in which a large number of sellers are offering similar but not identical products. Eg. biscuits, shampoo, washing soaps, tooth paste, tea etc.

Characteristics of Monopolistic Competition

  1. Many sellers
  2. Freedom of entry and exit
  3. Perfect information
  4. Heterogeneous product
  5. Every firm has negatively sloped demand curve

Determination of price and output in long run equilibrium under monopolistic competition

A monopolistic competitive firm achieves long-run equilibrium via the adjustment of market price, number of firms in the industry and scale of production of each firm. Due to this adjustment, each firm produces at a tangent point between its negatively sloped Average Revenue (AR) curve and its Long-run Average Cost (LRAC) curve to maintain economies of scale.

So, new two equilibrium conditions are achieved:

Here, first condition means each firm maximizes profit and has no reason to adjust its quantity of output.
The second condition means each firm in the industry is earning only a normal profit. Economic profit is zero and there is no economic loss.

Now,  these two equilibrium conditions can be divided into six specific conditions:
  1. Economic Inefficiency (P>MC)
  2. Profit Maximization (MR=MC)
  3. Market Control (P=AR>MR)
  4. Breakeven Output (P=AR=ATC)
  5. Excess Capacity (ATC>MC)
  6. Economies of Scale (LRAC>LRMC)
Hence, price and output is determined by the market structure and competitors price because there is high competition, difference between cost and price be very little. So, according to graph given above, price should increase slightly to maintain the few quantity of production.

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