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Characteristics of Monopolistic Competition

Discuss about the Computing Strategies in Monopolistic Competition.

Substitutes for each other. The typical characteristics of the market are product differentiation. Monopolistic market structure is the market structure that combines typical characteristics of monopoly and perfect competition. With monopolistic competition, there is free entry of firms to the market. Due to product differentiation, each firm behaves like a monopolist at its slender segment of an aggregate market of close substitutes. Each firm faces a downward sloping demand curve and it also has the power to influence the price for its commodity. Each firm seeks to maximize profits so it chooses its output in such a way that marginal cost is equal to marginal revenue. The first order condition of profit maximization under monopolistic competition is similar to that of under monopoly market: MR = MC. The only difference is that marginal revenue (MR) relies on the residual demand curve rather than market demand. On the other hand, residual demand is the demand for the commodity of a separate firm. In other words, it is aggregate market demand net of productivity of other monopolistic opponents (Roberts, 2014).

Monopolistic competition indicates the economic market model, where there are several sellers, who are selling differentiated goods however; these goods are not identical. Under this market structure, the demand curve is elastic as the differentiated that are sold by the firms are close substitutes. As a result, if one firm increases the price of its product, most of its customers will switch to commodities that are manufactured by other firms. The elasticity of demand makes it identical to pure competition where elasticity is perfect. As a monopolistic competitor has fewer rivals as compared to perfect competition, the demand curve is not perfectly elastic (Zhelobodko et al., 2012).

The suppliers in the monopolistically competitive markets are mostly price makers. The graph shows that the firm will produce the quantity at Q where marginal cost will be equal to marginal revenue. The price is set under this market structure based on where Q drops on the average revenue curve. The firm produces less and charges more, as they would do under perfect competition. This is mostly because; a monopolistically firm has market power. This in turn leads to deadweight loss for society. The green shaded area represents the profit of the firm made in the short term (Bertoletti & Etro, 2015).

In the long run, a firm mostly produce the amount of products where the long run marginal cost curve intersects with the marginal revenue. Although, a monopolistically competitive market makes profit in the short-run, the influence of its monopoly-like pricing leads to fall in demand in the long-run. The rise in cost and decrease in demand leads to tangency of the long-run average cost curve to the demand curve at the profit maximizing price of the commodity (Feenstra, 2016)

Profit Maximization Under Monopolistic Competition

The graph shows movement of a monopolistically competitive firm to long-run equilibrium. If firms are earning positive economic profits in a monopolistically competitive firm, other firms will get an inducement to enter the market. As a result, the share of each firm of the overall market demand becomes smaller and smaller. In other words, the demand curve facing a monopolistically competitive market shifts to the left. This procedure sustain until all the remaining firms in the market break even. Hence, outside firms will no longer have an inducement to enter the market (Balistreri & Rutherford, 2013).

In terms of economic efficiency, a firm that is in a monopolistically competitive industry behaves similarly as monopolistic firms. In a monopolistically competitive market, firms are mostly considered as a price maker that is, they are allowed to unilaterally alter or charge whatever they desire for their products without being influenced by market forces. The price is generally set where the profit maximizing level of production falls on the demand curve. This price also exceeds the marginal cost of the firm. As a result, customers will have to pay a price higher than they would pay in a perfectly competitive market. This in turn leads to significant drop in consumer surplus. On the other hand, producers will produce less of their products as compared to the quantity they would produce under perfectly competitive market. This will in turn offset the profits that they would gain from charging a higher price. This will in turn lead to fall in producer surplus (Nikaido, 2015).

The diagram shows that monopolistic competition generates deadweight loss as well as inefficiency that is represented by the orange triangle. Productive efficiency mostly takes place when a firm makes use of all resources in an effectual way. This takes place when a price of a commodity is set at its marginal cost that equals the average total cost of the commodity. On the other hand, in a monopolistic competitive market, a firm always set the price in excess of its marginal cost. This in turn leads to inefficiency in the market. The quantity is produced when green and blue lines intersect. Similarly, allocative efficiency takes place when a commodity is produced at a level that maximizes social wellbeing. This takes place when the price of a commodity is equal to its marginal benefits that are also equivalent to its marginal costs. However, as price of a commodity in a monopolistically competitive market is greater than its marginal cost, the market can never be allocative efficient (Assenza et al., 2015).

Computing Strategies in a Monopolistically Competitive Market

An industry where monopolistic competition prevails is that of a restaurant industry. Restaurants are mostly considered as a monopolistically competitive market and there are different restaurants in different sectors with no barriers to entry and exit. Every restaurant has close substitutes that mainly includes fast-food outlets as well as frozen-food sectors at local supermarkets (Erku?-Öztürk & Terhorst, 2016).

Profit maximization: It is supposed that a restaurant increases its price to some extent above those of identical restaurants with which it competes. As restaurants are dissimilar as compared to other restaurants, some individuals will continue to patronize it. Within restriction, the restaurants are able to set their individual price.

The Short Run: A restaurant competes with various other firms in a market in which there are no barriers to entry and exit. As a result, their demand curve is downward sloping. In other words, even if a restaurant increases its prices as compared to those of its competitors, it will have customers. As a result, marginal revenue curve of a restaurant will lie below the demand curve due to downward sloping demand curve. In order to raise its sale, a restaurant requires to lower its price. In other words, its marginal revenue from additional food items will be less than price (Stiglitz & Rosengard, 2015). 

The Long Run: With the entry of new firms, the availability for food items in a restaurant will increase. This will reduce the demand that is facing the restaurant and as a result, the demand curve will become more elastic. The demand curve for the restaurant will shift towards the left. The marginal curve also shifts along with the shift in the demand curve. Hence, new restaurants will continue to enter the market, until the particular restaurant stops making economic profit. The zero-profit solution takes place when the demand curve for the restaurant is tangent to its average total cost curve. As a result, the price for food items of the particular restaurant will fall along with fall in output. The restaurant will cover its opportunity cost and hence it will earn zero economic profit (Baumol & Blinder, 2015). 

The behaviors of firms in the market are as follows:

Every firm makes an independent decision related to price and output that is based on its commodity as well as its market and costs of production

Knowledge is broadly spread among participants however; it is unlikely to be perfect. In other words, customers can review all the menus that are obtainable in a restaurant before making the choice. Once they are inside the restaurant, they can again make choices by viewing the menu. However, they are not able to fully appreciate the meal available at the restaurant until they have eaten dinner (Schweinberger & Suedekum, 2015).

Efficiency in Monopolistic Competition

Due to increased risk associated with decision-making, the entrepreneur has a more imperative role as compared to the firms.

There is no barrier to entry and exit and as a result, there is freedom to enter or leave the market.

One of the central objectives of monopolistic competition is that the commodities are differentiated. There are mostly four types of differentiation that exists. The first differentiation deals with physical product differentiation where markets make the use of size, design, shape and performance to make their goods different. Market differentiation is also a part of differentiation with the help of which firms try to differentiation their goods by distinguishing packaging as well as other promotional methods. With the help of human capital differentiation, firms generate differences through the skill of its workers. The last type of differentiation is through distribution that includes mail order and internet shopping (Park et al., 2015).

Each firm has a downward sloping demand curve, and is considered as price makers rather than price takers. Each firm makes an exclusive commodity and as a result, they are able to charge a higher or lower price as compared to its competitors.

Firms that operate under monopolistic competition also require to get engage in advertising. Each firm is in a fierce competition with other local firms that offers the identical goods or service. The firms may require to advertise on a local basis in order to let their customers know their differences (Kirzner, 2015).

The firms that operates under monopolistic competition are assumed to be profit maximisers as the firms have a tendency to be undersized with entrepreneurs vigorously involved in organizing the business (Parenti, Ushchev & Thisse, 2017).

In this type of market structure, large number of independent firms competes in the market.

One of the proposed coalmines located in the north of the Galilee basin is the Carmichael coalmine. Due to economic transaction, third parties mostly face negative externalities. Under economic transaction, the producers and consumers are considered as the first and second parties. An individual or an organization is considered as the third party. In economics, an externality is the cost or benefit that affects a party who does not select to incur that cost or benefit. Externalities are mostly referred to as spillover effects and a negative externality is always associated with external cost. When negative externality takes place in an unregulated market, producers does not take accountability for external costs that exists (Phelan et al., 2017).

Industry Where Monopolistic Competition Prevails

The diagram shows the effect of negative externality where supply curve or the marginal cost curve is represented by the green line. On the other hand, the purple line represents the marginal cost curve that is faced by a firm with negative externality. The optimal production quantity is represented by Q2 where the negative externality in production is leads to Q1. The shaded portion represents deadweight loss (Lucas, 2016).

 The negative externalities that are associated with Adani Group's Carmichael coalmine are as follows:

It leads to lessening in life expectancy as it releases sulfur dioxide, ozone, heavy metals and particulates that is dangerous to health.

It also leads to respiratory hospital admission

It also leads to several diseases such as non-fatal cancer, ataxia, osteroporosia and renal dysfunction

It leads to reduction of crop yields due to some toxic emission that leads to fertilizing effect.

It also causes loss of ecosystems and degradation (Olabi, 2016).

One of the common types of negative externality is pollution that is caused by Adani Group's Carmichael coalmine. The individuals who are living around the coal mine factory will pay for the pollution that is caused by the Group. The negative externalities will be mostly in terms of higher medical bills as well as poorer quality of life. Thus, coal mining by Adani Group's Carmichael leads to negative cost to the individuals who are surrounding the factory. Coal mine releases greenhouse gas that leads to issues in the environment. Each year, Adani Group releases almost 145 million tons of sulfur due to smelting. As a result, it contaminates water due to explosives such as gravely toxic (Calvo & Pérez, 2016).

Externalities mostly represent an observable fact of low efficiency that is beyond the extent of decision makers under the aspect of resource allocation. In ecology of coal mining, external economy indicates to coal mining promote the expansion of the economy of the city rapidly. On the other hand, external diseconomy refers to pollution created in the environment as well as ecological damage that is associated coal mining (Roper, Love & Bonner, 2017).

The diagram shows negative externalities that are caused by activities related to coal mining. The coal industry is mostly considered as a competitive market. In this case, marginal social cost is greater than marginal private cost by the amount of the external cost. The external cost, here, indicates ecological damage as well as water pollution. The marginal social benefit is equal to marginal private benefit as it is assumed that there are no marginal benefits associated with coal mining. If the individuals take into account their private cost, it is likely that will end up with P1 as price and Q1 as quantity. On the other hand, they will not take into account the more effectual price P2 and effectual quantity Q2. As a result, free market is unproductive as at the quantity Q1, as in this case, social cost is larger as compared to social benefit. In that case, society will be better off in an overall basis if coal mining between Q1 and Q2 had not been generated. The government also requires to take charge of improvement as Adani Group only pays for coal mining and processing (Feng, Wang & Zhang, 2014).

Computing Strategies in Restaurant Industry


The company leads to negative externalities by polluting air and water and these externalities are more than simply an ethical issue. The internalization of negative externality of activities related to coal mining is the most necessary thing to establish ecological recompense mechanism. Mostly, ecological service function has a particular economic value and as a result, it can generously exchange in a perfectly competitive market. Figure 5 illustrates the relationship between marginal costs of Adani Group as well as loss of ecological service. In other words, it indicates the destruction of the ecosystem during coal mining activities. According to the theoretical analysis of Pigou tax, it is assumed that MPC indicates external diseconomy without taking coal-mining cost into consideration. On the other hand, Q1 and Q2 indicate losses related to ecological services that are generated by coal mining. Similarly, Ptax and P indicates coal price. Q1 indicates optimal losses of ecological services whereas; Q2 is the total amount of environment caused by Adani Group's Carmichael coal mine (Collier & Venables, 2014).

In order to address the market failure associated with coal mining it is imperative to supervise resource developers in order to restore damaged surroundings as well as pay for direct sufferers. It is also important to improve environmental quality as well as regulate the relationship between resource enhancement and environmental protection. This is considered as the most effectual method that will help to address market failure as well as policy failure.

References

Assenza, T., Grazzini, J., Hommes, C., & Massaro, D. (2015). PQ strategies in monopolistic competition: Some insights from the lab. Journal of Economic Dynamics and Control, 50, 62-77.

Balistreri, E. J., & Rutherford, T. F. (2013). Computing general equilibrium theories of monopolistic competition and heterogeneous firms. Handbook of Computable General Equilibrium Modeling, 1, 1513-1570.

Baumol, W. J., & Blinder, A. S. (2015). Microeconomics: Principles and policy. Cengage Learning.

Bertoletti, P., & Etro, F. (2015). Monopolistic competition when income matters. The Economic Journal.

Calvo, J. A. P., & Pérez, A. M. J. (2016). Optimal extraction policy when the environmental and social costs of the opencast coal mining activity are internalized: Mining District of the Department of El Cesar (Colombia) case study. Energy Economics, 59, 159-166.

Collier, P., & Venables, A. J. (2014). Closing coal: economic and moral incentives. Oxford Review of Economic Policy, 30(3), 492-512.

Erku?-Öztürk, H., & Terhorst, P. (2016). Innovative restaurants in a mass-tourism city: Evidence from Antalya. Tourism Management, 54, 477-489.

Feenstra, R. C. (2016). Gains from Trade Under Monopolistic Competition. Pacific Economic Review, 21(1), 35-44.

Feng, S., Wang, D., & Zhang, X. (2014). Study on Ecological Compensation for Coal Mining Activities Based on Economic Externalities. Journal of Geoscience and Environment Protection, 2(02), 151.

Kirzner, I. M. (2015). Competition and entrepreneurship. University of Chicago press.

Lucas, A. (2016). Stranded assets, externalities and carbon risk in the Australian coal industry: The case for contraction in a carbon-constrained world. Energy Research & Social Science, 11, 53-66.

Nikaido, H. (2015). Monopolistic Competition and Effective Demand.(PSME-6). Princeton University Press.

Olabi, A. G. (2016). Energy quadrilemma and the future of renewable energy. Energy, 108, 1-6.

Parenti, M., Ushchev, P., & Thisse, J. F. (2017). Toward a theory of monopolistic competition. Journal of Economic Theory, 167, 86-115.

Park, S. J., Cachon, G. P., Lai, G., & Seshadri, S. (2015). Supply chain design and carbon penalty: monopoly vs. monopolistic competition. Production and Operations Management, 24(9), 1494-1508.

Phelan, A. A., Dawes, L., Costanza, R., & Kubiszewski, I. (2017). Evaluation of social externalities in regional communities affected by coal seam gas projects: A case study from Southeast Queensland. Ecological Economics, 131, 300-311.

Roberts, K. (2014). The limit points of monopolistic competition. Noncooperative Approaches to the Theory of Perfect Competition, 3, 141.

Roper, S., Love, J. H., & Bonner, K. (2017). Firms’ knowledge search and local knowledge externalities in innovation performance. Research Policy, 46(1), 43-56.

Schweinberger, A. G., & Suedekum, J. (2015). De-industrialization and entrepreneurship under monopolistic competition. Oxford Economic Papers, 67(4), 1174-1185.

Stiglitz, J. E., & Rosengard, J. K. (2015). Economics of the Public Sector: Fourth International Student Edition. WW Norton & Company.

Zhelobodko, E., Kokovin, S., Parenti, M., & Thisse, J. F. (2012). Monopolistic competition: Beyond the constant elasticity of substitution. Econometrica, 80(6), 2765-2784.

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