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Monopolistic Competition
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Monopolistic competition occurs if many firms serve a market with free entry and exit, but in which one firm’s products are not perfect substitutes for the products of other firms.
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Assumptions of monopolistic competition large number of firms freedom of entry differentiated product (product differentiation) Chamberlain – SELLING COST downward-sloping demand curve Monopolistic Competition
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Selling Cost Demand is not determined by price alone Style, services, Selling activities Shift in demand due to these factors U Shaped Product Differentiation Real ( inherent characteristics different ) and Fancied ( product is same ; consumer is persuaded ) Firm is NOT a price taker but the price determination is limited
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Monopolistic Competition Industry and Product Group Industry: Same products Product Group: Closely related products High price and cross elasticities
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Short run equilibrium of the firm Rs Q O AC MR AR D PsPs QsQs MC
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Short run equilibrium of the firm Rs Q O AC MR AR D PsPs QsQs MC AC s
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Short run equilibrium of the firm Rs Q O AC MR AR D PsPs QsQs MC AC s
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Monopolistic Competition Assumptions of monopolistic competition large number of firms freedom of entry differentiated product downward-sloping demand curve Equilibrium of the firm short run long run
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Long run equilibrium of the firm Rs Q O LRAC MR L AR L D L PLPL QLQL LRMC Qs Ps SAR SMR
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Monopolistic Competition Assumptions of monopolistic competition large number of firms freedom of entry differentiated product downward-sloping demand curve Equilibrium of the firm short run long run underutilization of capacity in long run
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Excess capacity in the long run Rs Q O LRAC MR L AR L D L PLPL QLQL LRMC a b
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Limitations of the model imperfect information difficulty in identifying industry demand curve entry may not be totally free indivisibilities importance of non-price competition Comparing monopolistic competition with perfect competition and monopoly comparison with perfect competition Monopolistic Competition
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‘Group’ Equilibrium Product group Technical substitutability Economic substitutability Within group each firm has its own demand curve Slight product differentiation
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Long run equilibrium of the firm Rs Q O P1P1 LRAC D L under perfect competition Q1Q1
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Long run equilibrium of the firm perfect and monopolistic competition Rs Q O P2P2 P1P1 LRAC D L under perfect competition D L under monopolistic competition Q2Q2 Q1Q1
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Identifying Monopolistic Competition Two indexes: The four-firm concentration ratio The Herfindahl-Hirschman Index
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The four-firm concentration ratio The percentage of the value of sales accounted for by the four largest firms in the industry. The range of concentration ratio is from almost zero for perfect competition to 100 percent for monopoly. oA ratio that exceeds 40 percent: indication of oligopoly. oA ratio of less than 40 percent: indication of monopolistic competition.
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The Herfindahl-Hirschman Index (HHI) The square of the percentage market share of each firm summed over the largest 50 firms in a market. Example, four firms with market shares as 50 percent, 25 percent, 15 percent, and 10 percent. HHI = 50 2 + 25 2 + 15 2 + 10 2 = 3,450 A market with an HHI less than 1,000 is regarded as competitive. An HHI between 1,000 and 1,800 is moderately competitive.
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Limitations of Concentration Measures The two main limitations of concentration measures alone as determinants of market structure are their failure to take proper account of oThe geographical scope of a market oBarriers to entry and firm turnover
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