Lecture 11 - Theory of Monopolistic Competition | Microeconomics- Interaction between individual buyer-seller PDF Download

 Page 1


Theory of Monopolistic Competition 
1 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Lesson: Theory of Monopolistic Competition 
 
Lesson Developer: Bibek Kumar Rajak 
 
Designation: Assistant Professor/ Fellow in Economics 
 
College/University: Dyal Singh College/ Institute of 
Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Page 2


Theory of Monopolistic Competition 
1 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Lesson: Theory of Monopolistic Competition 
 
Lesson Developer: Bibek Kumar Rajak 
 
Designation: Assistant Professor/ Fellow in Economics 
 
College/University: Dyal Singh College/ Institute of 
Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Theory of Monopolistic Competition 
2 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
 
 
 
 
Table of Content 
1. Learning Objectives 
2. Introduction 
3. Features of Monopolistic Competition 
4. Demand Curve of firms under monopolistic competition 
5. Equilibrium of firms or price and output determination under monopolistic 
competition in the short run 
5.1 Case of firm earning abnormal/supernormal profit 
5.2 Case of firm earning normal profit 
5.3 Case of firm incurring losses  
6. Equilibrium of firms or price and output determination under monopolistic 
competition in the long run 
7. Excess capacity under monopolistic competition 
8. Exercises 
9. Multiple Choice Questions 
10. References 
 
 
 
 
 
 
 
 
 
 
 
Page 3


Theory of Monopolistic Competition 
1 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Lesson: Theory of Monopolistic Competition 
 
Lesson Developer: Bibek Kumar Rajak 
 
Designation: Assistant Professor/ Fellow in Economics 
 
College/University: Dyal Singh College/ Institute of 
Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Theory of Monopolistic Competition 
2 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
 
 
 
 
Table of Content 
1. Learning Objectives 
2. Introduction 
3. Features of Monopolistic Competition 
4. Demand Curve of firms under monopolistic competition 
5. Equilibrium of firms or price and output determination under monopolistic 
competition in the short run 
5.1 Case of firm earning abnormal/supernormal profit 
5.2 Case of firm earning normal profit 
5.3 Case of firm incurring losses  
6. Equilibrium of firms or price and output determination under monopolistic 
competition in the long run 
7. Excess capacity under monopolistic competition 
8. Exercises 
9. Multiple Choice Questions 
10. References 
 
 
 
 
 
 
 
 
 
 
 
Theory of Monopolistic Competition 
3 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
 
 
 
 
1. Learning Objectives 
After reading this lesson you will be able to understand  
? The meaning and definition of monopolistic market. 
? Features of monopolistic competition market.  
? Firm’s behavior in monopolistic market. 
? Price and output determination of firms under monopolistic competition in the 
short run and long run. 
? Concept of excess capacity and economic inefficiency. 
? Resource allocation under monopolistic competition. 
? Comparison between perfect competition and monopolistic competition. 
  
 
 
 
 
 
 
 
 
Page 4


Theory of Monopolistic Competition 
1 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Lesson: Theory of Monopolistic Competition 
 
Lesson Developer: Bibek Kumar Rajak 
 
Designation: Assistant Professor/ Fellow in Economics 
 
College/University: Dyal Singh College/ Institute of 
Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Theory of Monopolistic Competition 
2 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
 
 
 
 
Table of Content 
1. Learning Objectives 
2. Introduction 
3. Features of Monopolistic Competition 
4. Demand Curve of firms under monopolistic competition 
5. Equilibrium of firms or price and output determination under monopolistic 
competition in the short run 
5.1 Case of firm earning abnormal/supernormal profit 
5.2 Case of firm earning normal profit 
5.3 Case of firm incurring losses  
6. Equilibrium of firms or price and output determination under monopolistic 
competition in the long run 
7. Excess capacity under monopolistic competition 
8. Exercises 
9. Multiple Choice Questions 
10. References 
 
 
 
 
 
 
 
 
 
 
 
Theory of Monopolistic Competition 
3 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
 
 
 
 
1. Learning Objectives 
After reading this lesson you will be able to understand  
? The meaning and definition of monopolistic market. 
? Features of monopolistic competition market.  
? Firm’s behavior in monopolistic market. 
? Price and output determination of firms under monopolistic competition in the 
short run and long run. 
? Concept of excess capacity and economic inefficiency. 
? Resource allocation under monopolistic competition. 
? Comparison between perfect competition and monopolistic competition. 
  
 
 
 
 
 
 
 
 
Theory of Monopolistic Competition 
4 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
2. Introduction 
 
Monopolistic competition is one of the imperfectly competitive markets along with 
monopoly, oligopoly and others, but unlike others, monopolistic competition market 
is very common in most of the developed as well as in some of the developing 
economies today. Unlike extreme markets such perfect competition and monopoly, 
which are hardly seen in real world, this form of market is widely found in the real 
world. It is a market form in which there are large numbers of firms without any 
capacity to influence the market price but attain some degree of market power by 
producing differentiated products. Take the example of readymade garment industry 
in India there you find thousands of firms which are actually producing these 
garments but their products are slightly different from each other. You can also take 
the example of Restaurants in Delhi which are providing north Indian cuisine, go to 
yellow pages of Delhi or any other method of searching the number of Restaurants in 
Delhi you may end up finding thousands of them actually offering north Indian 
Cuisine, some may be very large restaurants with multiple branches in almost all 
parts of Delhi, some are not very big but with almost equal number of branches in 
the city, some may be small with one or two branches or some may be very small 
(not very popular and confined to the locality), but all of them providing north Indian 
food with different tastes and prices. You can also think of many more such 
industries in which large numbers of firms are operating and they are producing the 
same of but their products are not homogeneous but they are different from each 
other.  
Monopolistic competition is a market form in which you may find the element of 
monopoly as well as perfect competition. It has large number of firms, free entry and 
exit which are found in perfect competition, but unlike perfect competition where the 
firms produce homogeneous products without any market power; in this market the 
firms enjoy certain degree of market power through product differentiation. Though 
the degree of market power enjoyed by these firms is very low compared to a firm 
under monopoly. Let us now discuss the features of monopolistic competition market 
in detail: 
 
3. Features of Monopolistic Competition 
 
(i) Large number of firms 
 
Page 5


Theory of Monopolistic Competition 
1 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Lesson: Theory of Monopolistic Competition 
 
Lesson Developer: Bibek Kumar Rajak 
 
Designation: Assistant Professor/ Fellow in Economics 
 
College/University: Dyal Singh College/ Institute of 
Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Theory of Monopolistic Competition 
2 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
 
 
 
 
Table of Content 
1. Learning Objectives 
2. Introduction 
3. Features of Monopolistic Competition 
4. Demand Curve of firms under monopolistic competition 
5. Equilibrium of firms or price and output determination under monopolistic 
competition in the short run 
5.1 Case of firm earning abnormal/supernormal profit 
5.2 Case of firm earning normal profit 
5.3 Case of firm incurring losses  
6. Equilibrium of firms or price and output determination under monopolistic 
competition in the long run 
7. Excess capacity under monopolistic competition 
8. Exercises 
9. Multiple Choice Questions 
10. References 
 
 
 
 
 
 
 
 
 
 
 
Theory of Monopolistic Competition 
3 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
 
 
 
 
1. Learning Objectives 
After reading this lesson you will be able to understand  
? The meaning and definition of monopolistic market. 
? Features of monopolistic competition market.  
? Firm’s behavior in monopolistic market. 
? Price and output determination of firms under monopolistic competition in the 
short run and long run. 
? Concept of excess capacity and economic inefficiency. 
? Resource allocation under monopolistic competition. 
? Comparison between perfect competition and monopolistic competition. 
  
 
 
 
 
 
 
 
 
Theory of Monopolistic Competition 
4 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
2. Introduction 
 
Monopolistic competition is one of the imperfectly competitive markets along with 
monopoly, oligopoly and others, but unlike others, monopolistic competition market 
is very common in most of the developed as well as in some of the developing 
economies today. Unlike extreme markets such perfect competition and monopoly, 
which are hardly seen in real world, this form of market is widely found in the real 
world. It is a market form in which there are large numbers of firms without any 
capacity to influence the market price but attain some degree of market power by 
producing differentiated products. Take the example of readymade garment industry 
in India there you find thousands of firms which are actually producing these 
garments but their products are slightly different from each other. You can also take 
the example of Restaurants in Delhi which are providing north Indian cuisine, go to 
yellow pages of Delhi or any other method of searching the number of Restaurants in 
Delhi you may end up finding thousands of them actually offering north Indian 
Cuisine, some may be very large restaurants with multiple branches in almost all 
parts of Delhi, some are not very big but with almost equal number of branches in 
the city, some may be small with one or two branches or some may be very small 
(not very popular and confined to the locality), but all of them providing north Indian 
food with different tastes and prices. You can also think of many more such 
industries in which large numbers of firms are operating and they are producing the 
same of but their products are not homogeneous but they are different from each 
other.  
Monopolistic competition is a market form in which you may find the element of 
monopoly as well as perfect competition. It has large number of firms, free entry and 
exit which are found in perfect competition, but unlike perfect competition where the 
firms produce homogeneous products without any market power; in this market the 
firms enjoy certain degree of market power through product differentiation. Though 
the degree of market power enjoyed by these firms is very low compared to a firm 
under monopoly. Let us now discuss the features of monopolistic competition market 
in detail: 
 
3. Features of Monopolistic Competition 
 
(i) Large number of firms 
 
Theory of Monopolistic Competition 
5 
Institute of Lifelong Learning, University of Delhi 
In a monopolistic market there are large numbers of firms in the 
industry. As stated above some may be very big in size, some may be 
big or some may be comparatively small, but in this market no firm 
can influence the market price by virtue of their size despite the fact 
that all the firms set their own prices. 
 
 
(ii) Differentiated Products 
 
In this market firms produce differentiated products i.e. products of 
each firm are different from other firms in terms of quality, colour, 
size, taste, packing, fragrance, etc. Each firm claims that their 
products are better than others. Unlike perfect competition where all 
firms produce homogeneous products. 
 
(iii) Profit Maximization 
All firms under this market want to maximize their profits. Their main 
objective is to maximize the profit given the cost conditions.  
i.e. Max p = TR-TC. 
 
 
(iv) Free Entry and Exit 
 
In monopolistic competition there is no barriers for new firms to enter 
into the industry. Any person can open a new restaurant or chain of 
restaurants in Delhi. Entry of new firms into the restaurant industry is 
free here. Any firm if wishes can shut down their operation or leave 
the industry whenever they want. Therefore, entry or exit of firms in 
the industry is free in such markets. 
 
(v) Advertising/selling costs 
 
Advertisement costs are there in monopolistic market; firms spend a 
lot of money on advertisements. It is the advertisement or selling 
strategy through which firms attract consumers or try to prove that 
their products or services are different and better from others. 
 
(vi) Firm is a price maker 
  
Despite being in large number firms set their own price, prices are not 
determined by the industry as the case for perfectly competitive 
market. But as stated above they cannot influence the market price.  
 
(vii) Non-price competition 
 
In monopolistic market the competition is not of price but of acquiring 
the market power and they enjoy some degree of market power 
through product differentiation.