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MODULE: Managerial Economics

NUMBER AND TITLE OF ASSIGNMENT SUBMITTED:

Examine the Market form of Monopolistic Competition and provide examples of how this Market Form impacts on the Strategic Behavior of Businesses

WEEKDAY SATURDAY

DATE SUBMITTED: 23 July 2007

STUDENT NUMBER: 20619988

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CONTENTS

Introduction Page 2

Definition and overview Page 4

Short-run Price and Output determination Page 5

Long-run Price and Output determination Page 7

Product Variation and Selling Expenses Page 10

Examples of Monopolistic Competition

Marketing game Page 11

Conclusion Page 14

Reference Page 15

Introduction

Market structure refers to the competitive environment in which the

buyers and sellers of the products operate. The Market Structure

strongly influences the Price and Output determined, by organizations in

the real world.

According to Dominick Salvatore (2004:324) there are primarily four

types of Market Structures that are identified:

Perfect competition,

Pure monopoly,

Monopolistic competition,

Oligopoly.

Characteristics of the four types of Market structures

Perfect competition

Many buyers and sellers of a product, each too small to affect the price

Product is homogeneous

Perfect mobility of resources

Economic agents have perfect knowledge of the market conditions

Monopoly

A single firms sells a product for which there is no close substitutes.

Entry into the industry is very difficult or impossible (as evidenced that

there is a single firm in the industry.

Monopolistic competition

There are many sellers of a differential product and entry into or exit from

the industry is rather easy in the long run. Dominick Salvatore (2004:324)

Oligopoly

There are a few sellers of a homogeneous differential product. Entry into

the industry is possible, however it is not as easy due to the small number

of firms in the industry. Dominick Salvatore (2004:324)

Companies operate in one of the above four mentioned Market

Structure’s by virtue of their product/service they offer. For the

purposes of this assignment, we need to focus on Monopolistic

Competition, and the impact it has on the strategic behavior of

business.

Definition and overview of Monopolistic Competition

As implied by the name, Monopolistic Competition is combination of a

Monopoly and Competition. The competitive element is a result of the fact

that there are many sellers of the differentiated product each too small to

affect each other. The monopolistic element arises from the product

differentiation; the product sold by each seller is somewhat different from

the product sold by another seller. The monopoly power is however

severely limited, due to the availability of the many close substitutes.

Hence, if the seller increases his price even moderately, it would stand to

lose a great deal of its sales.

Monopolistic Competition, is most common in the retail and service

sectors of our economy; i.e. Fast-food outlets, drugstores, video rental

stores and pizza parlors. Firms in each of these businesses have some

monopoly power over their competitors based of their product

differentiation, location, service, range of products and cost. However,

due to the availability of market substitutes, their market power is very

limited.

Due to each firm retailing or providing a differentiated service, we cannot

draw the market supply or demand curve. Also there is no single

equilibrium price for the product but instead a cluster of them.

In contrast to a perfectly competitive firm, monopolistically competitive

firms can determine the characteristics of the products and the amount of

selling expenses to incur, as well as price and quantity. Dominick

Salvatore (2004:349)

Short-Run Price and Output determination

Due to Monopolistically Competitive firms producing differentiated

products, the demand curve is negatively sloped, this is attributed to there

being so many close substitutes for the product, which results in the

demand curve being highly price elastic.

The fewer the products, the higher the Price elasticity of demand is.

Dominick Salvatore (2004:351)

As in the case of firms in the other forms of market structure examined

the best level of output of the monopolistically competitive firm in the

short run is given by the one at which marginal revenue equals marginal

cost, provided that the price exceeds the average variable cost.

MR = MC Dominick Salvatore (2004:351)

Short-run Price & Output ~ Monopolistic Competition

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As per the internet site in the short run, then, the monopolistically

competitive firm faces limited competition. There are other firms that sell

products that are good, but not perfect, substitutes for the firm's own

product. In the words of British economist Joan Robinson, every firm has

a monopoly of its own product. When the product is differentiated, that

means the firm has some monopoly power -- maybe not much, if the

competing products are close substitutes, but some monopoly power, and

that means we must use the monopoly analysis, as if Figure 1 below.

We see that, as usual in monopoly analysis, the marginal revenue is less

than the price. The firm will set its output so as to make marginal cost

equal to marginal revenue, and charge the corresponding price on the

demand curve, so that in this example, the monopoly sells 1000 units of

output (per week, perhaps) for a price of $85 per unit.

But this is just a short run situation. We see that the price is greater than

the average cost (which is $74 per unit, in this case) giving a profit of

$11,000 per week. We remember too that this is economic profit -- net

of all implicit as well as explicit costs -- so this profitable performance will

attract new competition in the long run. What that means is that new firms

will set up, and existing firms will change their products, so that there will

be more, and closer, substitutes in the long run. That will shift the

demand for this firm's profits downward, and perhaps cause the cost

curves to shift upward as well, squeezing the profit margins.

Long-Run Price and Output determination

In the short run firms in a monopolistically competitive market earn profits,

and then more firms will enter the market in the long run. The demand

curve will shift to the left for each monopolistic competitor until it becomes

tangent to the firm’s LAC curve. Eventually in the long run all

monopolistically competitive firms will break even and produce on the

negatively sloped portion of their LAC curve. Dominick Salvatore

(2004:352)

The demand curve facing a typical or representative monopolistically

competitive firm in the long run is referred to as D’. As more firms enter

the monopolistically competitive market in the long run, (that is the

demand curve D’ is lower and more price elastic than the demand curve

D that the firm is faced with in the short run) therefore each monopolistic

competitor is left with a smaller share of the of the market and more price

elastic demand curve because of the greater range of competition in the

long run. Dominick Salvatore (2004:352)

Long-run Price & Output ~ Monopolistic Competition

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As per the internet in monopolistic competition, when one firm or product

variety is profitable, it will attract more competition -- more substitutes and

closer substitutes for the profitable product type. Thus, demand will shift

downward and (perhaps) costs will increase. This will go on as long as

the firm and its product type remain profitable. A new "long run

equilibrium" is reached when (economic) profits have been eliminated.

This is shown in Figure 2:

In this example, the firm can break even by selling 935 units of output at a

price of $76 per unit. The profit -- zero -- is the greatest profit the firm can

make, so profit is being maximized (as usual) with the output that makes

MC=MR .Zero (economic) profit is also the condition for long run

equilibrium in a p-competitive industry. But this equilibrium is not the ideal

that the long run equilibrium in a p-competitive industry is. Many

economists feel that the long run equilibrium in a monopolistic industry

has some problems:

Inefficiency

Notice that, either in the long run or in the short, the price is greater than

marginal cost. But the condition for efficient production is that price is

equal to marginal cost. Thus, an individual firm's output is less that would

be efficient, according to the traditional standard.

Excess capacity

We see that, in the long run, the firm is not producing at the bottom of its

long run average cost curve. Instead, it is operating on a scale that is

smaller and less efficient -- the firm has a capacity to produce more at a

lower average cost. To put it a little differently, each firm is serving a

market that is too small, and there are too many firms, so that the product

group as a whole has the capacity as per the internet site.

Product Variation and Selling Expenses under Monopolistic

Competition

A firm can increase its expenditures on product variation and selling effort

in order to increase the demand for its product and make it more price in

elastic under monopolistic competition. A change in characteristics of the

product that a monopolistic competitor undertakes in order to make its

product more appealing to consumers is referred to as Product variation.

Selling expenses, are the cost incurred in order to sell the product;

i.e. advertising cost, increasing sales force and providing better service

for products.

Product variation will increase the firms sales and profits, however they

also add to the running expenses. More emphasis must be spent on

Product variation and selling efforts as long as the MR, from these efforts

exceeds the MC, and until MR=MC.

i.e. advertising cost, increasing sales force and providing better service

for products. Dominick Salvatore (2004:352)

Example of a Monopolistic Competition

The Marketing game

A good example of Monopolistic Competition is the exercise that was

given to us for the Market Management course. Four groups made-up

the total product market and in this market we were made to compete

against each other, all having a similar product. The differentiation was in

the features and after sales service that was provided to the consumer.

All groups were given the same budget for the first year thereafter the

budget changed according to how much of the market segment the group

was able to capture.

Through the game, we could see that all the groups competed very

vigorously against each other, each trying to have the little extra that

would help it achieve maximum sales. Through active marketing and

proper market analysis we were able to start taking the lead in the

market.

As we progressed through the weeks we compiled the following data that

is reflected in the following graphs.

Sales per segment

In the attached graph we can see the sales per market segment;

Sales per segment

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Market Share

In the attached graph we can see the manner in which each group used

its capital, resulted in it gain or losing market share.

Summary

Advertisement vs Quantity sold

In the attached graph we can see the impact the advertising cost has on

the number of units that are sold.

market share

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Conclusion of the Market Game

As we progressed through the game, we learnt that we needed to firstly

identify the Market in which we wanted to be in and their requirements.

Once that was done we did our market research and decided that our

product must be feature filled and value for money. As each week

progressed we had to adapt based on the information we got from the

market surveys and make new strategic plans to counter our opponents.

By having a very aggressive market domineering strategy; ie.

increasing/reducing the features, increasing/reducing the advertising

expense, increasing/reducing the sale force, etc. thereby ensuring that

the product was differentiated by both features and service from our

competitors, we realized our objective of making the most amount profit

and having the largest market share.

Strategic plans are in place to guide the organization in achieving its

strategic objectives. With the changing environments, it is important that

for the objectives to remain static and realistic, the strategic plan has to

be manipulated to ensure that the organizations objectives are not

jeopardized. This not only entails capturing potential opportunities that

arise with the changing markets, but also to alleviate any threats that

emerge from negative marketing environmental influences.

Conclusion

As can be seen, in Monopolistically competitive markets it is very important for a company to differentiate its product so as to ensure that it grows its Market share. Thereby consuming a large portion of the existing/fixed market. Business need to ensure they are competitive in both price as well as quality, as this can only allow them to gain more share.

References

Salvatore, D, 2004, 5th ed, Managerial Economics in a Global Economy, New York, Harcourt College Publishes, Fort Worth.

Internet Site International Trade Theory and Policy Last Updated on 2/15/07