OBJECTIVES

The objectives of this report are:

1. To define and describe the characteristics of Monopolistic Competition

2. To differentiate Monopolistic Competition from other market structures

3. To recognize product differentiation

4. To identify how price discrimination affects the economic profit of a firm

5. To show how a firm yields profit or loss through graphs

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INTRODUCTION

What is the status of Philippine economy? Based on researches, The economy

of the Philippines is the 12th largest economy in Asia and the 32nd largest economy in

the world by purchasing power parity according to the International Monetary Fund in

2010. It was the 5th largest economy in South East Asia. According to Goldman Sachs,

the Philippine economy will become the 14th largest economy in the world by 2050.

The said development occurred because of the undying growth of different firms

throughout the country. These firms may vary in different ways, the way they operate,

manage and render their goods and services. Competitions of different firms may also

air in this kind of situation and prove what the most effective market structure for the

Philippines is. Understanding these firms will make people a lot more aware of system

used either positive or negative.

MONOPOLISTIC COMPETITION

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Monopolistic Competition is one of the four basic market structures,

characterized by a large number of small firms, similar but not identical products sold by

all firms, relative freedom of entry into and exit out of the industry, and extensive

knowledge of prices and technology. As such, firms operating in monopolistic

competition are extremely competitive but each has a small degree of market control.

The real world is widely populated by monopolistic competition. Perhaps half of the

economy's total production comes from monopolistically competitive firms. The best

examples of monopolistic competition are retail trade, including restaurants, clothing

stores, and convenience stores. Specific example of this is given by the many tablets

for headache available in the market (for example, Biogesic, Medicol, Advil). Another

example is given by the many different brands of soap available in the market like

Safeguard, Palmolive, Bioderm, GreenCross.

CHARACTERISTICS OF MONOPOLISTIC COMPETITION

No barriers to entry or exit

Entry into monopolistically competitive industries is relatively easy compared to

oligopoly or pure monopoly. Because monopolistic competitors are typically small firms,

both absolutely and relatively, economies of scale are few and capital requirements are

low. Exit from monopolistically competitive industries is relatively easy. Nothing

prevents an unprofitable monopolistic competitor from holding a going-out-of-business

sale and shutting down.

Large number of small firms

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A monopolistically competitive industry contains a large number of small firms,

each of which is relatively small compared to the overall size of the market. This

ensures that all firms are relatively competitive with very little market control over price

or quantity. In particular, each firm has hundreds or even thousands of potential

competitors. It is characterized by a fairly large number of firms not by the hundreds or

thousands of firms in pure competition. It involves the ff.

Small Market Shares – each firm has a comparatively small percentage of the

total market and consequently has limited control over market price.

No collusion – The presence of relatively large number of firms ensures that

collusion by a group of firms to restrict output and set prices unlikely.

Independent Action – with numerous firms in an industry, each firm can

determine its own pricing policy without considering the possible reaction of

rival firms.

Face competition

Monopolistic competitors face competition like perfect competition through the ff.

PRODUCT DIFFERENTIATION

The goods produced by firms operating in a monopolistically competitive market

are subject to product differentiation. The goods are essentially the same, but they have

slight differences. The firms compete more on product differentiation than on price.

Product differentiation is the primary reason that each firm operating in a

monopolistically competitive market is able to create a little monopoly all to itself.

Product differentiation is usually achieved in one of three ways,

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1. Physical differences

- Product differentiation may entail physical or qualitative differences in the

product themselves. Real differences in functional features, materials, design, and

workmanship are vital aspects of product differentiation. Personal computers, for

example, differ in terms of storage capacity, speed, graphic displays, and included

software.

2. Perceived differences

- In other cases goods are only perceived to be different by the buyers,

even though no physical differences exist. Such differences are often created by

brand names, trademarks, packaging, and celebrity connections. When a consumer

wants to buy toothpaste, he specifies the brand of toothpaste he wants. He does not

go to the store and orders toothpaste; he goes to the store and orders “Colgate” or

Close Up” or whatever brand he wants.

3. Support services

- In still other cases, products that are physically identical and perceived to be

identical are differentiated by support services. Even though the products purchased

are identical, one retail store might offer "service with a smile," while another

provides express checkout.

ADVERTISING

Advertising is commonly used by firms operating under monopolistic competition

as a way to create product differentiation and thus to acquire some degree of market

control and thus charge a higher price. It helps to provide information of the company’s

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product or operation, usually through media such as television, radio, newspapers,

magazines, and the Internet, to promote or maintain sales, revenue, and/or profit.

It is frequently used by monopolistic competition to accomplish two related

goals--product differentiation and market control. To the extent that a firm can inform

buyers about physical differences or create the perception of such differences, then

product differentiation increases.

Moreover, with product differentiation there will be market control. If advertising

convinces buyers that the goods are different (and better) than other products, then a

firm can charge it with a higher price.

Power to set prices somewhat like a monopoly

Resource Mobility

- The resources might not be as "perfectly" mobile as in perfect competition,

but they are relatively unrestricted by government rules and regulations, start-up

cost, or other substantial barriers to entry.

Extensive Knowledge

- Buyers do not know everything, but they have relatively complete

information about alternative prices. They also have relatively complete information

about product differences, brand names, etc. Moreover, each seller also has

relatively complete information about the prices charged by other sellers so that they

do not inadvertently charge less than the going market price.

- Extensive knowledge also applies to technology and production

techniques. Every monopolistically competitive firm has access to essentially the

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same production technology. Some firms might have a few special production tricks,

but these differences are not major.

DEMAND CURVE of Monopolistic Competition

The four characteristics of monopolistic competition mean that a monopolistically

competitive firm faces a relatively elastic, but not perfectly elastic, demand curve. Each

firm in a monopolistically competitive market can sell a wide range of output within a

relatively narrow range of prices.

The demand curve faced by a monopolistically competitive seller is highly, but

not perfectly, elastic. It is precisely this feature that distinguishes monopolistic

competition from pure monopoly and pure competition. The monopolistic competitor’s

demand is more elastic than the demand faced by a pure monopolist because the

monopolistically competitive seller has many competitors producing closely

substitutable goods. The pure monopolist has no rival at all. Yet, for two reasons, the

monopolistic competitor’s is not perfectly elastic like that of pure competitor. First, the

monopolistic competitor has fewer rivals; second, its products are differentiated, so they

are not perfect substitutes.

A monopolistically competitive firm is a price maker, with some degree of control

over price. Once again, unlike perfect competition, a monopolistically competitive firm

has the ability to raise or lower the price a little, not much, but a little. And like

monopoly, the price received by a monopolistically competitive firm (which is also the

firm's average revenue) is greater than its marginal revenue.

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The

illustration above shows that the marginal revenue curve (MR) lies below the

demand/average revenue curve (D = AR). While marginal revenue is less than price,

because demand is relatively elastic, the difference tends to be relatively small. For

example, 5 units of output correspond to a Php5 price. The marginal revenue for the

fifth unit is Php4.80, less than price, but not by much.

SHORT – RUN PRODUCTION: Profit or Loss

The analysis of short-run production by a monopolistically competitive firm

provides insight into market supply. The key assumption is that a monopolistically

competitive firm, like any other firm, is motivated by profit maximization. The firm

chooses to produce the quantity of output that generates the highest possible level of

profit, given price, market demand, cost conditions, production technology, etc.

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A firm maximizes profit by selecting the quantity of output that generates the

greatest gap between the total revenue line and the total cost line in the upper panel or

at the peak of the profit curve in the lower panel. In this example, the profit maximizing

output quantity is 6. Any other level of production generates less profit.

The monopolistically competitive firm maximizes its profit or minimizes its loss in

the short. By producing the output at which marginal revenue equals marginal cost (MR

= MC).

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LONG RUN PRODUCTION – Only a Normal Profit

In the long run, firms will enter a profitable monopolistically competitive industry

and leave an unprofitable one. So a monopolistic competitor will earn only a normal

profit in the long run or, in other words, will only break even.

In the long run, with all inputs variable, a monopolistically competitive industry

reaches equilibrium at an output that generates economies of scale or increasing

returns to scale. At this level of output, the negatively-sloped demand curve is tangent

to the negatively-sloped segment of the long run-average cost curve.

This is achieved through a two-fold adjustment process.

The first of the folds is entry and exit of firms into and out of the industry. This

ensures that firms earn zero economic profit and that price is equal to average cost.

The second of the folds is the pursuit of profit maximization by each firm in the

industry. This ensures that firms produce the quantity of output that equates marginal

revenue with short-run and long-run marginal cost.

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