Unit-4 Pricing Under Monopolistic Competition POE | BBA First Year

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Pricing Under Monopolistic Competition

  • Monopolistic competition has the characteristics of both perfect competition and monopoly in the market. Monopolistic competition is more common than pure competition or pure monopoly. In this article, we will understand monopolistic competition and look at the characteristics, price-output determination and conditions of equilibrium.

Monopolistic Competition

  • To understand monopolistic competition, let us look at the soap and detergent market in India. There are many famous brands in this segment like Lux, Rexona, Dettol, Dove, Pierce etc.
  • Since all manufacturers produce soap, this appears to be an example of perfect competition. However, upon closer inspection, we found that each vendor makes slight changes to the product to make it different from its competitors.
  • Hence, Lux Beauty focuses on soap making, Liril on freshness, Dettol on antiseptic properties, Dove on smooth skin etc. This allows each seller to attract buyers based on certain factors other than price.
  • This market is a mixture of both perfect competition and monopoly and is a classic example of monopolistic competition.

Features Of Monopolistic Competition

Large number of sellers

  • In a market with monopolistic competition, there are a large number of sellers who each have a small share of the market.

Product differentiation

  • In monopolistic competition, all brands try to create product differentiation to add an element of monopoly over competing products. This ensures that there is no perfect substitute for the product offered by the brand. Therefore, the manufacturer can increase the price of the product without worrying about losing all its customers to other brands. However, in such a market, while not all brands are perfect choices, they are close substitutes for each other. Therefore, the seller You may lose at least some customers to your competitors.

Freedom of entry or exit

  • Like perfect competition, firms can freely enter and exit the market.

Non-price competition

  • In monopolistic competition, sellers compete on factors other than price. These factors include aggressive advertising, product development, better distribution, after-sales services, etc. Sellers do not cut the price of their products but charge high costs for promotion of their goods. If firms engage in a price war, which is likely under perfect competition, some firms may exit the market.

Price-Production Determination Under Monopolistic Competition: Equilibrium of a Firm

  • In monopolistic competition, since the product is differentiated among firms, each firm does not have perfectly elastic demand for its products. In such a market, all companies determine the price of their products themselves. Therefore, it faces a downward sloping demand curve. Overall, we can say that as the differentiation between products decreases, the elasticity of demand increases.

The figure above depicts a firm facing a downward sloping but flat demand curve. It also has a U-shaped short-term cost curve.

  • Conditions for balancing an individual firm
  • The conditions for price-production determination and equilibrium of the individual firm are as follows: a
  1. MC = MR
  2. MC curve intersects MR curve from below.

In the figure, we can see that MC curve intersects MR curve at point E. on this point,

  • Equilibrium price = OP and
  • Equilibrium Output = OQ

Now, since the cost per unit is BQ, we have

  • Super-normal profit per unit (price-cost) = AB or PC.
  • Total super-normal profit = APCB

The following figure shows a firm earning losses in the short run.

  • From the figure, we can see that cost per unit is greater than the firm’s price. so,

Long Term Balance

  • If firms in monopolistic competition earn extraordinary profits in the short run, new firms will have an incentive to enter the industry. As these firms enter, profits per firm decline as aggregate demand becomes shared among a larger number of firms. This continues until all companies earn only normal profits. Therefore, in the long run, firms in such a market earn only normal profits.

  • As we can see in the above figure, the average revenue (AR) curve touches the average cost (ATC) curve at point X. This corresponds to quantity Q1 and price P1. Now, at equilibrium (MC = MR), all super-normal profits are zero since average revenue = average cost. Therefore, all companies earn zero super-normal profits or only normal profits.
  • It is important to note that in the long run, a firm is in a state of equilibrium with excess capacity. In simple words, it produces less quantity than its full capacity. From the above figure, we can see that the firm can increase its production from Q1 to Q2 and reduce the average cost. However, it does not do this because it reduces average revenue more than average cost. Therefore, we conclude that It can be seen that in monopolistic competition, firms do not operate optimally. Every firm always has excess production capacity.
  • In case of losses in the short run, loss making companies will exit the market. This continues until the remaining companies earn normal profits.

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By Atul Kakran

My name is Atul Kumar. I am currently in the second year of BCA (Bachelor of Computer Applications). I have experience and knowledge in various computer applications such as WordPress, Microsoft Word, Microsoft Excel, PowerPoint, CorelDRAW, Photoshop, and creating GIFs.

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