Monopolistic Competition
Topic Question:
Is monopolistic competition more efficient than perfect competition?
A market is an economic environment in which buyers and sellers in an industry operate. There are four degrees of competition in the market: monopoly, oligopoly, monopolistic competition and perfect competition. As firm numbers rise from one single firm dominating the market in a monopoly to many small firms in perfect competition, the less influence an individual firm’s supply has on total supply and therefore on price because it competes with a large number of other firms.
The basic model of perfect competition is based on five main assumptions. The first assumption is that a price taking behaviour exists for all parties meaning that they have to accept the market price and cannot influence it. This is due to the negligible effect each individual firm has on the market price due to its small market share. The second assumption is that the market is characterised by free entry and exit meaning that new firms can enter and exit the market without any restrictions on the process and thus, without incurring any special costs. Special costs would be costs that the new firms have to pay although the incumbents did not. Furthermore, the output of the firms is homogeneous meaning that the goods are identical to the consumer and therefore the goods are not substitutes of each other. Another characteristic in perfect competition is that perfect knowledge exists for all parties, thus, transparency of each firm’s action is assumed. Lastly, firms are not interdependent meaning that they do not behave strategically and anticipate any reaction by the competition through their own actions.
Fig. 1 shows the perfect competition model in the short run. The firm will always stop production at where marginal cost equals marginal revenue (MC=MR) as this is the output maximising point q*. Every individual firm’s q* sums up to the total industry’s aggregate demand Qe at the
Is monopolistic competition more efficient than perfect competition?
A market is an economic environment in which buyers and sellers in an industry operate. There are four degrees of competition in the market: monopoly, oligopoly, monopolistic competition and perfect competition. As firm numbers rise from one single firm dominating the market in a monopoly to many small firms in perfect competition, the less influence an individual firm’s supply has on total supply and therefore on price because it competes with a large number of other firms.
The basic model of perfect competition is based on five main assumptions. The first assumption is that a price taking behaviour exists for all parties meaning that they have to accept the market price and cannot influence it. This is due to the negligible effect each individual firm has on the market price due to its small market share. The second assumption is that the market is characterised by free entry and exit meaning that new firms can enter and exit the market without any restrictions on the process and thus, without incurring any special costs. Special costs would be costs that the new firms have to pay although the incumbents did not. Furthermore, the output of the firms is homogeneous meaning that the goods are identical to the consumer and therefore the goods are not substitutes of each other. Another characteristic in perfect competition is that perfect knowledge exists for all parties, thus, transparency of each firm’s action is assumed. Lastly, firms are not interdependent meaning that they do not behave strategically and anticipate any reaction by the competition through their own actions.
Fig. 1 shows the perfect competition model in the short run. The firm will always stop production at where marginal cost equals marginal revenue (MC=MR) as this is the output maximising point q*. Every individual firm’s q* sums up to the total industry’s aggregate demand Qe at the
References: Besanko, David, and Ronald R. Braeutigam. Microeconomics. Hoboken, NJ: John Wiley, 2011. Print. Morgan, C. W., Michael L. Katz, and Harvey S. Rosen. Microeconomics. London: McGraw-Hill Higher Education, 2009. Print.