Transcript Price Determination Under Monopolistic Competition

Meaning and Characteristic
 Demand and Cost Curves
 Product differentiation
 Price determination (short and long periods)
 Group Equilibrium
 Selling Costs
 Comparisons between different areas of
competition
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Simple meaning (for students):It is competition faced by different firms
trading in the same range of product , with
the product differentiating in minor terms with
each other
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Definitions :Monopolistic Competition is a market
situation where there are many producers but
each offers a slightly differentiated product
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Large no. of firms and buyers :
Like perfect competition there are large no.
of sellers BUT the firm size is small unlike perfect
competition
Each firm can decide its own price as they
have limited control over the market UNLIKE
perfect competition
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Product differentiation :
It is the situation wherein the buyers can
distinguish one product from the other
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Why does it arise ?
It arises due to the differentiation of the
products e.g. shape, durability, color, size
etc.
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Examples :
Colgate, Pepsodent, Prudent, Sensodyne
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Freedom of Entry and Exit :
There is freedom of entry and exit BUT its not
absolute . There are many difficulties
Price Policy :
Each firm has its own price policy . It means
that if a firm wants to sell more units of its
product it will have to lower the per unit price
.
 Less Mobility :
Neither factors of production nor goods and
services are mobile .
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Imperfect Knowledge :
Buyers and sellers are ignorant about the
price . It is so because due to the firms
product differentiation .
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Non-Price Competition :
Different firms compete without
changing the price of the product.
Hence, sellers attract customers by
offering free gifts .
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Because of product differentiation, demand
curve(AR curve) of a firm under monopolistic
competition is downward sloping. Marginal
revenue curve is also downward sloping.
Demand curve under monopolistic
competition is more elastic than under
monopoly. It is because if a producer raises
the price of his product, then some of the
customers stop buying from him and shift their
clientele to other producers who have not
raised the price and vice-versa.
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Average cost curve, average variable cost
curve and marginal cost curve are U-shaped
even under monopolistic competition. Special
feature of imperfect competition is selling
cost, incurred on the advertisement of the
product. According to Chamberlin, selling
cost curve is also U-shaped. On account of
product-differentiation, supply curve of the
industry cannot be drawn under monopolistic
competition.
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According to Chamberlin, “A general class of
product is differentiated if only sufficient basis
exists for distinguishing the goods of one
dealer from those of another. Such a basis
may be real or fancied, so long as it is of any
importance whatever to buyers and leads to
a preference for any variety of the product
over another.”
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Goods are not homogeneous as in perfect
competition.
The goods are close substitutes.
Product differentiation may both real and artificial.
Producer gets the name or brand legally
patented.
Aim of product differentiation is to control price
and increase profit. It may increase average cost.
Satisfies people’s urge for variety. Hence, it
becomes necessary to pay a little higher price.

The main objective of product differentiation
is to increase the influence of the producer in
the determination of price. The producer is no
longer a price-taker but a price maker.
Consequently, demand curve assumes
negative slope, signifying more demand
when price falls and less demand when it
rises. It is because of product differentiation
that selling costs have great influence over
demand curve.

A producer aims to get the maximum profit
even under monopolistic competition. We
have seen that profit is maximum when
MR=MC. In case of monopolistic competition
MR is not equal to AR. If a firm wants to sell
more units it has to lower the price per unit
due to which AR and MR are downward
sloping curves from left to right. A firm
produces up to that limit where its MC=MR,
and MC curve cuts MR curve from below.
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Short Period Equilibrium in Monopolistic
Competition:
It refers to the period in which production can
be increased, only up to existing production
capacity in response to increase in demand.
A firm will be in equilibrium when its MC=MR,
MC curve cuts MR from below. The firm may
face 3 situations: (1) Super Normal Profits,
(2) Normal Profits (3) Loss.
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Super Normal
Profits:
Figure shows that firm is in
equilibrium at point
E, because at this point
MC=MR.
It indicates that the firms
equilibrium output is OM.
Price
equilibrium output is
OP(=BM).
BM is greater than average
cost AM(BM>AM). Hence,
the firm earns super normal
profit equivalent to BA per
unit. Total super normal
profits
of firm in equilibrium is ABPC.
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Normal Profits:
Figure shows that firm is in
equilibrium at point E
where MC=MR and OM will
be the equilibrium
output. Price of the
equilibrium
output. Price of the
equilibrium
output is OP(=AM) and
average
cost is also OP(=AM). This is
because, AR curve is
touching
AC curve at point A. Hence,
in
the position of equilibrium
AR=AC
and the firm earns normal
profits.
Minimum Loss:
Figure shows that firm
will be in equilibrium at
point
E. At this point
MC=MR. In equilibrium
position, the
firm will produce OM
units of output. Price of
equilibrium output
OM is OP1(=AM) and
average
cost OP(=BM).
Average cost of the firm
is more
than the price.

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Long period
equilibrium in
monopolist :
It is that time in which
the firm can change
the production
capacity in response
to change in
demand . New firms
can enter the
industry .
Firms can run normal
profit only .
There are a number of firms producing
products . These collectively act as a
group and are called an Industry .
 The achievement of equilibrium and
attainment of optimum point is known as
Group Equilibrium .
 Example : Group of firms producing
Toothpastes .
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Excess capacity is
the difference
between optimum
output and actual
output in the long
run equilibrium .
It is said to be when
the Average Cost is
minimum .
There are mixed viewpoints regarding
excess capacity about different authors .
 However,
The correct policy is to reduce the
number of differentiated products until
each remaining product can be
produced at its least cost output .
 Thus we conclude it is not necessary
wasteful .
