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13.1 Market Imperfection

(A) Quantitative and Qualitative Differences: Traditionally a competitive market is considered an ideal form of market. As a rule almost all markets are competitive in nature. Only in exceptional cases certain market imperfections may cause departure from competition. Such exceptions to competition are in the form of monopoly, oligopoly or duopoly. However, all these forms are numerically and quantitatively dissimilar to competition. Traditional analysis does not take account of qualitative differences. The number of firms may remain fairly large to make the market appear competitive. Yet there may be noticeable varieties in the price charged and the profits earned by individual firms. This can be explained thus: such modern markets have started emerging in the 1920s. Traditional competitive analysis could not explain them. The conclusion drawn was that modern competitive firms deliberately create qualitative differences in their products and in their selling activities. In other words, modern firms differentiate their products. Firms producing biscuits, soaps, chocolates, stereo systems and TV sets are all examples of product differentiating firms. This new trend among producers demands a different approach to analyze their behavior. Two young economists Joan Robinson in England and Prof. E. H. Chamberlin in the U.S presented their respective theories on Imperfect Competition and Monopolistic Competition in the earlier half of the 20th century. We will presently review monopolistic competition.

(B) Main Features of Monopolistic Competition: Monopolistic competition is a modern form of the market. A large variety of goods are sold in such a market. Its main features can be stated as follows:

i) Large Number: The number of firms operating under monopolistic competition is sufficiently large. Moreover there is freedom of entry. There are no quantitative restrictions or differences in market conditions. However, each firm differs from its rivals in some qualitative respect.

ii) Close Substitutes: In case of a monopoly there are no substitutes available. Under monopolistic competition firms produce very close substitutes. Chocolates of one company may serve a similar purpose as that of some other firm. The only difference may be of some variation in the quality of the product.

iii) Group: Firms under monopolistic competition together form a group. They cannot be called an industry. This is because their products are somewhat dissimilar and not homogenous as under competitive industry.

iv) Product Differentiation: Under monopolistic competition products are differentiated. This is the outstanding feature of this form of market. Otherwise monopolistic competition closely resembles perfect competition. The fundamental difference between the two is that products are no more homogenous. Goods produced are deliberately differentiated. By differentiation we mean the goods are made to appear somewhat different and superior to those produced by other firms. Product differentiation may be real or apparent. By real differentiation we mean that a difference is maintained in some physical or chemical composition of a product or in the taste and appearance of that product. This is easily done with the help of attractive packaging; or some extra services are rendered. A product can also be marketed as superior using local advantage. When products are differentiated more buyers are likely to be attracted. Thereby the firm gains extra control over demand and market conditions. The demand curve of a firm will then alter to the advantage of a firm. It will become more flexible and shift upwards. A firmís capacity to alter the demand curve for its own product is the chief analytical feature of monopolistic competition. Under no other form of market do producers attempt to influence the demand which is entirely based on consumer behavior. Gains of product differentiation have been shown in Figure 49. In the figure dd is the original demand curve that the firm faces before product differentiation.

On this demand curve at market price P the firm sells output Q. When the firm differentiates its product successfully its demand curve alters and is now d1d1. On the new demand curve the firm at point R1 can charge a price as high as P1 and sell old output Q. It could also charge the same price P and sell a very large output Q1 at point R3. Or then the firm could choose a somewhat higher price (higher than P1 but lower than P2) P2 at point R2 and sell a somewhat larger quantity Q2.

(v) Selling (Advertising) Cost: Selling Cost (SC) is another outstanding feature of a monopolistic competitive market. This in the form of advertisement expenditure. Selling Cost and Product Differentiation together enable the producer to maintain some control over market conditions and influence the shape of the demand curve. Both features are interdependent. Whenever a product is differentiated it is necessary to inform buyers; and advertisement is the only medium through which buyers can be told about superiority of that product. Selling Cost by itself is apparent product differentiation. When a product does not contain any genuine qualitative difference, buyers can be made to treat a product differently through advertisements. So whenever products are differentiated and advertised, the market becomes a monopolistic competition. These are the hallmarks of this form of market. The presence of selling cost increases the firmís cost of production. In order to recover it, firms have to charge a higher price. The net effect of a monopolistic competitive market is pricing goods at a higher rate. Consumers have to bear this extra expenditure.


13.1 Market Imperfections
13.2 Equilibrium under Monopolistic Competition

Chapter 14

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