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Monopolistic Competition And Optimum Product Diversity

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Question:

Discuss about the Monopolistic Competition and Optimum Product Diversity.
 
 

Answer:

Introduction:

There are several techniques in the hands of the government to control the production of any specific commodity within the market. To reduce the production of the commodity, the government impose taxes on them. On other hand, the government also imposes quota on the commodity’s quantity sold by the producer. Government impose several excise duties and taxes to control the customer’s consumption. Tax imposition influence the demand and supply part of the market depending on the one who bears the burden of tax.  The supply of alcohol and impact of taxation on the same within the economy has been shown by the diagram below and discussed henceforth.

From the above drawn diagram, both the scenario has been depicted in which once the supplier is the main tax bearer and in the other the consumer is the main tax bearer. In the left side the demand curve is flatter than the supply curve. In this case the majority of tax burden is borne by the supplier himself. On the right side, the supply curve is flatter than demand curve. Here the burden of the taxes is delivered by the consumer. After the imposition of tax, the consumption pattern of alcohol changes. In economy, the imposition of tax is only depending on the elasticity of the demand and supply curve and the reaction of the consumer to the tax rate (Cowen & Tabarrok, 2015).

Other than taxation, the government may also impose quota on the price level below which alcohol could not be sold. The effect of such a price bar has been elucidated below:

From the above diagram, E is the equilibrium level. The government imposes quota that is charge the minimum price over equilibrium price (at Po). As a result he demand of the quantity supplied is reduced (Qe to Qo). Due to surplus supply in the production of goods, the producer has to face a loss as their products remain unsold. Hence, they start to reduce their level of production and therefore supply curve shifts backward and equilibrium is restored at a point where the new supply curve (SS1) intersects the demand curve. In other words, equilibrium is restored at the price level dictated by the government.

Thus from the above discussion it can be said that taxes are better than quota because imposition of taxes has dual benefit. This is because through taxation the government collects more revenue from the market and due to high tax the production and consumption decreases. On other hand, quota reduces the production of alcohol but people started getting adjusted to the high price and market gets cleared without any benefit to the government.he long run is the time period in which all these factors become variable and market are said to operate at their optimum possible level. The situation of the economy in long run under monopolistic competition has been shown through the diagram below and discussed thereafter.

 

As per the given question, the minimum price quoted by the table manufacturer in the long run for selling each unit of table is $200. Monopolistic producer has the motive to earn the maximum possible profit and thereby always decide to sell the quantity dictated by the intersection of MC and MR curve. This is the situation where a monopolist firm is not being able to get or earn super-normal profit. The firm can only remain in business by staying on its respective break-even point. As seen in the diagram above that the minimum point of LRAC curve that is $200 is situated to the right of the intersecting point of MC & MR. Hence, it can be said that the firm which is operating in the downward sloping part of its LRAC is charging higher than the price dictated by the minimum point of LRAC.

There is existence of excess capacity under monopolistic competition. The reason behind such excess capacity has been shown in the diagram below:

The ideal situation would have been production at the point where the LRAC is minimum that is the cost of producing each unit or good is minimum. Under monopolistic competition this point is unattainable as at this point the revenue yield by the firm is lesser than the cost. Therefore, any rational producer never thinks of operating at this point. Since they do not operate at the socially optimum level, therefore there remains excess capacity of the firms to produce more goods in the economy.

Oligopoly market is a case of imperfect market. The name has been derived from the Greek word Oligos which means a few and Pollen which means to sell. It is the market where few sellers dominate and control the entire demand of the economy. The primary characteristics of oligopoly market have been discussed below followed by some real world example of oligopoly market in Australia.

Number of sellers: The oligopoly market has been characterised with the existence of few sellers. There has been no specific number mentioned to categorise the term few but they should be small enough in number to strongly influence the market.

Competition & Rigidity in Price: Since there are only a handful firms in the market, each of them faces tough competition from their opponent. Everyone tries their best to maximize the level of profit earned by them and tries to influence the market price of the goods sold. On other hand, the changes in price are always avoided due to the restriction possessed by other competitors.

Interdependence: There exists strong degree of interdependence amongst the firms in oligopoly market. This is because due to existence of very few firm, the decision of one firm affects the others. Usually it has been observed that the players decide upon the price via collusion.

 


Uniformity Issues: There exists issues in uniformity within oligopoly as some firms are potentially big whereas some are very small compared to them.

Barriers: There is existence of rigidity in the market. Any firm which wishes to enter the market has to face strong opposition from the existing firms. The barrier to exit is lesser than the barrier to enter the market.

Three real world example of monopolistic competition in the Australian economy are their banking sector, super market chains and the pharmaceutical industry. The reason behind categorising them under oligopolistic competition is given as follows:

Pharmaceutical industry: There is existence of only a few pharmaceutical industries as compared to the number of consumers. This is because there has been a natural barrier to entry poised by the high cost associated with this industry. On other hand, the barriers are also created by the pharmaceutical giants in order to maintain their position. Few such giants operating in Australian economy are Pfizer, Alphapharm, GSK and Sanofi-Aventis.

Supermarket chains: Australia is the home of few supermarket giants like Aldi, Woolsworth and Coles. They have the responsibility of catering to the lion’s share demand for FMCGs in Australia. They often have price wars amongst them whereby each wants to attract their customer base by reducing their price and consequently everyone ends up selling at low price.

Banking sector:  Almost 90% of Australia’s financial decision is controlled by the big 4 banks of the nation namely ANZ, NAB, WBC and CBA. Since they hold the majority power, hence this industry in Australia falls under oligopolistic competition.

Monopolistic competition is the market where there is existence of multiple numbers of firms each engaged with selling the same product. The products of monopolistic firms are not identical in nature. The market structure and characteristics of this firm is given as follows:

 


Barriers: There is lack of stringency in the market with regards to the entry and exit. The firms with the motive of earning super-normal profit enter the market and whenever they cannot earn the profit, they try to leave the market.

Buyers and Sellers: There are several producers in monopolistic market as compared to the oligopolistic market. Each producer has certain hold on the price-output decision of the economy.

Knowledge: The monopolistic market has always been engulfed with deficiency in knowledge and lack of information. This makes the producers unaware of the exact taste of the people and the consumers remain unaware of the different variety of products available in the market.

There are several products that falls under monopolistic market. Three such products that fall under monopolistic market and is a part of Australia are coffee, cereals and restaurants.

Coffee: This globally acknowledged beverage can be consumed either when it is hot or when it is cold. In addition, there are several varieties of coffee to choose from. On other hand, multiple numbers of coffee shops exists in the market each quoting the price of their product in accordance with people’s demand.

Restaurant: There are umpteen numbers of big and small restaurants in the Australian economy each working with the same purpose of catering food. Most of them cater a wide range of foods for their consumer to choose from thereby bringing in product differentiation.

Cereals: The cereals that people consume for breakfast are available in a wide range of variety. It depends on the consumer whichever they want to eat. On other hand, the producer always try to bring in more variety in the market in order to kkep pace with the changing demand and attract more consumer.

Duopoly is that market where the two sellers supply or serve to the consumer within a particular region. It gives them the power to control the price of commodities sold and gives shape the consumers demand. It is the simple type of oligopoly. Natural duopoly exists when two firms sustain in the market and the entry of the third firm is barred by the already existing firm and the huge cost associated with the entry. The features of natural duopoly are as follows:

Existence of only two firms: Duopoly market is that when two firms take power to control the demand of the whole market for a specific commodity. Other firms that are present in the market have no power to control the quantity produced in the market and its price.

Seller agreement: Under the market both the seller can take independent decision. There is  no such agreement regarding the charged prices or the produced quantity of goods and services.

 

Influence: When the two sellers are affected by the opponent’s decision and they thought that their partner is not influenced by them is the duopoly form. Here both the sellers predict the decision that their opponent would take and they execute their decision accordingly.

In the above diagram the red coloured line is the market demand under natural duopoly. It is formed by the two intersecting blue lines which highlights the reaction function of the two firms. Entry into the market of duopoly by the new firms has always been kept at bay by the existing firms and even at times the restrictions are imposed by the government. Often it has been observed that the existing firms goes into collusion and decides upon the commodity price such that they can maximize their profits (Mankiw, 2014). On other hand if any other firms try to enter the market they are going to face a heavy loss and because of that steps back from entering. Entry of new firms are often restricted by the government if it can be found that the existing firm has comparative advantage and is able to meet the market demand.

 

References:

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

Bernanke, B., Antonovics, K., & Frank, R. (2015). Principles of macroeconomics. McGraw-Hill Higher Education.

Cowen, T., & Tabarrok, A. (2015). Modern Principles of Microeconomics. Palgrave Macmillan.

Mankiw, N. G. (2014). Principles of macroeconomics. Cengage Learning.

Morrow, J., & Dhingra, S. (2014). Monopolistic competition and optimum product diversity under firm heterogeneity. Journal of Political Economy.

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

Pigou, A. C. (2013). The economics of welfare. Palgrave Macmillan.

Rios, M. C., McConnell, C. R., & Brue, S. L. (2013). Economics: Principles, problems, and policies. McGraw-Hill.

Schwager, J. D., & Etzkorn, M. (2017). Supply?Demand Analysis: Basic Economic Theory. A Complete Guide to the Futures Market: Technical Analysis and Trading Systems, Fundamental Analysis, Options, Spreads, and Trading Principles, 359-371.

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