Monopolistic Competition

A2 Microeconomics: This is a revision presentation on aspects of monopolistic competition designed for A2 business economics students

1. Monopolistic Competition A2 Micro

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3. Monopolistic Competition Monopolistic competition is a form of imperfect competition It can be found in many real world markets ranging from clusters of sandwich bars, other fast food shops and coffee stores in a busy town centre to pizza delivery businesses in a city or hairdressers in a local area Monopolistic competition is similar to perfect competition, some economist regard it as more realistic, because the products are differentiated

4. Assumptions of the Market There are many producers and many consumers - the concentration ratio is low Consumers perceive that there are non-price differences among products i.e. there is product differentiation – competition is strong, plenty of consumer switching takes place Producers have some control over price - they are “price makers” not “price takers” but the price elasticity of demand is higher than it would be under a situation of monopoly The barriers to entry and exit into and out of the market are low

5. Monopolistic Competition: Falling AR and MR, Price and Profits MC Price, Cost Output AC AR M R

6. Monopolistic Competition: MC Price, Cost Output AC AR M R P1 Q 1

7. Monopolistic Competition: MC Price, Cost Output AC AR M R P1 Q 1 C 1

8. Monopolistic Competition: MC Price, Cost Output AC AR M R P1 Q 1 C 1 Abnormal profits

9. Identify three factors that affect the “pricing power” of an individual firm in monopolistic competition 1. There still may be many competitors keeping pricing ‘low’ 2. Product ‘differentiation’ allows firm to charge a different price to reflect any unique qualities of the product/service 3. Barriers to entry and exit of the market are low so this requires firms to price competitively

10. Long Run Equilibrium for Monopolistic Competition MC Price, Cost Output AC AR M R P1 Q 1 Unlike monopoly, there are no barriers to entry. This means that short run supernormal profit attracts new producers into the market

11. Long Run Equilibrium for Monopolistic Competition MC Price, Cost Output AC AR2 MR2 P2 Q 2 As more firms enter the market, the demand curve facing any existing firm moves to the left

12. Long Run Equilibrium for Monopolistic Competition MC Price, Cost Output AC AR2 MR2 P2 Q 2 The demand curve continues to move to the left until it is tangential to the AC curve. At this point, the firm is at its profit-maximising level of output (because MR = MC) but is making normal profit (because AR = AC)

13. How does Monopolistic Competition differ from Perfect Competition? Perfect Competition Monopolistic Competition Number of producers (sellers in the market) Many Many Types of goods and services available for consumers Does the firm have control over their own prices? Is branding / marketing important? Are entry barriers zero, low or high? Does this market structure lead to allocative efficiency in the long run? Does this market structure lead to productive efficiency in the long run?

14. How does Monopolistic Competition differ from Perfect Competition? Perfect Competition Monopolistic Competition Number of producers (sellers in the market) Many Many Types of goods and services available for consumers Homogeneous Differentiated Does the firm have control over their own prices? Is branding / marketing important? Are entry barriers zero, low or high? Does this market structure lead to allocative efficiency in the long run? Does this market structure lead to productive efficiency in the long run?

15. How does Monopolistic Competition differ from Perfect Competition? Perfect Competition Monopolistic Competition Number of producers (sellers in the market) Many Many Types of goods and services available for consumers Homogeneous Differentiated Does the firm have control over their own prices? No – price takers Yes – some pricing power Is branding / marketing important? Are entry barriers zero, low or high? Does this market structure lead to allocative efficiency in the long run? Does this market structure lead to productive efficiency in the long run?

16. How does Monopolistic Competition differ from Perfect Competition? Perfect Competition Monopolistic Competition Number of producers (sellers in the market) Many Many Types of goods and services available for consumers Homogeneous Differentiated Does the firm have control over their own prices? No – price takers Yes – some pricing power Is branding / marketing important? No Yes – key non-price competition Are entry barriers zero, low or high? Does this market structure lead to allocative efficiency in the long run? Does this market structure lead to productive efficiency in the long run?

17. How does Monopolistic Competition differ from Perfect Competition? Perfect Competition Monopolistic Competition Number of producers (sellers in the market) Many Many Types of goods and services available for consumers Homogeneous Differentiated Does the firm have control over their own prices? No – price takers Yes – some pricing power Is branding / marketing important? No Yes – key non-price competition Are entry barriers zero, low or high? Zero barriers Low barriers Does this market structure lead to allocative efficiency in the long run? Does this market structure lead to productive efficiency in the long run?

18. How does Monopolistic Competition differ from Perfect Competition? Perfect Competition Monopolistic Competition Number of producers (sellers in the market) Many Many Types of goods and services available for consumers Homogeneous Differentiated Does the firm have control over their own prices? No – price takers Yes – some pricing power Is branding / marketing important? No Yes – key non-price competition Are entry barriers zero, low or high? Zero barriers Low barriers Does this market structure lead to allocative efficiency in the long run? Yes: Price = MC Not quite (P>MC) Does this market structure lead to productive efficiency in the long run?

19. How does Monopolistic Competition differ from Perfect Competition? Perfect Competition Monopolistic Competition Number of producers (sellers in the market) Many Many Types of goods and services available for consumers Homogeneous Differentiated Does the firm have control over their own prices? No – price takers Yes – some pricing power Is branding / marketing important? No Yes – key non-price competition Are entry barriers zero, low or high? Zero barriers Low barriers Does this market structure lead to allocative efficiency in the long run? Yes: Price = MC Not quite (P>MC) Does this market structure lead to productive efficiency in the long run? Yes – min LRAC No – higher LRAC

20. Economic efficiency? Prices are above marginal cost – meaning that the equilibrium is not allocatively efficient Saturation of the market may lead to businesses being unable to exploit fully economies of scale - causing average cost to be higher than if less firms and products were in the market Critics of heavy spending on marketing and advertising argue that much of this spending is wasted and is an inefficient use of scarce resources. The debate over the environmental impact of packaging is linked strongly to this aspect of monopolistic competition

21. Application: The UK Taxi and Private Hire Vehicle Industry

22. Application: The UK Taxi and Private Hire Vehicle Industry

23. Application: The UK Taxi and Private Hire Vehicle Industry

24. Application: The UK Taxi and Private Hire Vehicle Industry

25. Examples of Price and Non-Price Competition in the Taxi Industry Pre-arranged agreed fares Different price per time/mile Different price for ‘hail’ over ‘booked ’ vehicles ‘Luxury’ cars, personal driver ‘ Disabled-access’ for car use Later pick-up times (after 12pm)

26. Examples of Price and Non-Price Competition in the Taxi Industry Pre-arranged agreed fares Different price per time/mile Different price for ‘hail’ over ‘booked ’ vehicles ‘Luxury’ cars, personal driver ‘ Disabled-access’ for car use Later pick-up times (after 12pm)

27. London Taxi Fares in 2013 The table shows typical fares and journey times based on distance for three types of tariff. Fares and journey times may be higher if there are delays or heavy traffic. There is a minimum fare of £2.40 at all times. Source: Transport for London website Distance Approx  journey  time Monday to Friday  06:00 - 20:00 Monday to Friday 20:00 - 22:00 Saturday and Sunday  06:00 - 22:00 Every night 22:00 - 06:00 Public holidays 1 mile 6 - 13 mins £5.60 - £8.80 £5.60 - £8.80 £6.80 - £9.00 2 miles 10 - 20 mins £8.60 - £13.80 £9.00 - £13.80 £10.40 - £14.60 4 miles 16 - 30 mins £15 - £22 £16 - £22 £18 - £27 6 miles 28 - 40 mins £23 - £29 £28 - £31 £28 - £33 Between Heathrow  and  Central London 30 - 60 mins £45 - £85 £45 - £85 £45 - £85

28. How might an increase in competition impact on consumers? London Taxi Fares in 2013 The table shows typical fares and journey times based on distance for three types of tariff. Fares and journey times may be higher if there are delays or heavy traffic. There is a minimum fare of £2.40 at all times. Source: Transport for London website Distance Approx  journey  time Monday to Friday  06:00 - 20:00 Monday to Friday 20:00 - 22:00 Saturday and Sunday  06:00 - 22:00 Every night 22:00 - 06:00 Public holidays 1 mile 6 - 13 mins £5.60 - £8.80 £5.60 - £8.80 £6.80 - £9.00 2 miles 10 - 20 mins £8.60 - £13.80 £9.00 - £13.80 £10.40 - £14.60 4 miles 16 - 30 mins £15 - £22 £16 - £22 £18 - £27 6 miles 28 - 40 mins £23 - £29 £28 - £31 £28 - £33 Between Heathrow  and  Central London 30 - 60 mins £45 - £85 £45 - £85 £45 - £85 Lower Prices More availability of taxis Better quality taxis Increased safety for journey home

29. Get help from fellow students, teachers and tutor2u on Twitter: # econ3 @ tutor2u_econ www.tutor2u.net