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Short Run and Long Run Conditions

Discuss about the Monopolistic Competition Market and Products.

As stated by Rubinstein (2012), a monopolistic market is characterized by many consumers and more than one producer and the products are non-homogeneous. The products are substitute goods in nature to some extent. Because of this characteristic, no one has complete control over the market. The consumers have knowledge of the market where non-price differences among various goods and services prevail, although perfect information will be absent in the market. The barriers to entering the market will be more than the perfect competition and lesser than monopoly market. Although in the long run there will be no cost of entry and exit in the market. Producers have control over the prices of the goods which only supplied by them.

 The products being sold by the sellers are similar but differentiated. This means there are differences regarding the demand elasticity of the goods. If the price of good becomes too high, the consumers will shift to the next best product easily. According to the ideas of Sacks et al. (2015), the demand for the products is not perfectly elastic as the number of producers is less than that in a perfectly competitive market. Hence, the products and services being sold in this market are not perfect substitutes. The concept of short run states that at least one of the factors of production are fixed, while the other factors may vary. In the long run, all the factors of production are variable. Following the views of Osharin et al. (2014), in the short run, a firm operating in a monopolistic market tries to minimize its losses. The production condition for the firm is MR = MC. This means the producers produces at that point where their marginal revenue (MR) is equal to marginal cost (MC). In the views of Zhelobodko et al. (2012), the situation of profit will only arise when the producer’s average total cost is lower than the market price he is getting. The situation is depicted in the figure below.

As shown in the figure above, the monopolistic price is Pm and the quantity supplied at that price is Qm. Here, AR is the perceived demand curve faced by the producer at which he thinks the demand will be. In realty, he faces the proportionate demand curve as shown in the figure. According to this figure, the average total cost is lower than Pm. As stated by Parenti, Thisse and Ushchev (2014), this gives the producer the opportunity to earn an economic profit. If the average total cost were above the monopolistic price margin, the producer would have incurred a loss. In that situation, if he thinks he can make a profit, in the long run, he will remain in the market. Otherwise, he might leave. In the views of Assenza et al. (2015), in the long run, if other firms see the opportunity of profit, they will enter the market, which will divide the demand into further fragments, making the profit margin low for all the firms. This will increase the cost of productions, and the inefficient firms will leave the market. The remaining firms will earn the normal profit then. As stated by Nikaido (2015), in the long run, the firms will produce where the average cost is equal to the price corresponding to the point where the marginal revenue and marginal cost ae equal. The situation is depicted in the figure below.

Efficiency in Monopolistic Competition

As shown in the figure above, if a producer moves beyond MR = MC, he will incur more marginal cost than marginal revenue. He produces where ATC is equal to AR at point A. The point B represents allocative efficiency at the marginal cost which is equal to market price. The point C represents a situation in the long run, where the ATC is minimum and productive efficiency prevails. According to the ideas given by Roberts (2014), the producers do no operate here; hence, they operate with excess potential or capacity. As shown in the figure, if the producers want to produce more than Qm they will incur a loss.

In the views of Nocco, Ottaviano and Salto (2014), the profits or the losses in the short run gets eroded by the entry and exits in the market. While in short run profit attracts more sellers, they will join the market eroding the profit margin. Similarly, prevailing loss in the market will make some inefficient firms leave the market. This will erode the loss margin in the long run.

 As shown in figure 2 above, the productive efficiency comes when the producer is operating at the point C. It will make the producer operate at the point where the average total cost is least. Following the ideas of Dhingra and Morrow (2012), the allocative efficiency will occur when the market price is equal to the marginal cost, which is given in the figure above by the point B. Productive efficiency will occur in a monopolistic competition when the producers use the resources efficiently. Allocative efficiency in this market structure occurs when the firms produce to maximize the social welfare.

In monopolistic competition, there are many buyers and sellers as well, who specializes in selling their products. As the products are similar but differentiated, the producers have somewhat control over their products’ prices. The hotel restaurant industry is an example of monopolistic competition. In this industry, there are chains of restaurants which are engaged in monopolistic market structure. Due to its high number of suppliers and consumers, the market seems like a competitive market, and the different types of products with different prices shows the characteristics of a monopoly market. In the ideas of Lee, Sardeshmukh and Hallak (2015), the restaurant industry in Australia has faced a boom due to various reasons since past few years. The mining boom in the country and the tourism industry has caused this massive increase in demand for the restaurant industry. The sports industry in the country also brings many international tourists in the country. All these reasons are responsible for the increasing demand for restaurants. The cost of factors in the country is low due to the high functioning agricultural sector. It increased the supply in the industry along with improved business ethics.

Restaurant Industry as an Example

The key features of this industry of the restaurant industry are as follows:

A large number of producers: The market is characterized by a large number of restaurant businesses. Examples of some of the producers of this industry are Attica, Brae-Birregurra, Sepia, Quay, Ester, and many other chains of restaurants. These restaurants serve a huge number of customers over one year. According to the ideas of Lábaj et al. (2016), a large number of producers has come to the market for meeting the demand from a huge number of consumers in the country. Over the past five years, the restaurant industry of Australia has witnessed a growth of %.6 percent. The annual revenue in this industry is $14 billion for the last year which contributes a lot to Australia’s national income. 290,142 people of Australia's total population are employed in this industry. Hence it can also be said that the industry plays a huge role in reducing unemployment in the country. Following the ideas of Balistreri and Rutherford (2013), it can be said that, as the demand for the restaurants is increasing, the number of suppliers are also increasing.

Product differentiation: The producers operating in this market are producing similar products. All are producing foods for mainly high end customers. But these foods are somewhat differentiated. Some of the restaurants are specialized in sea foods, some of them are specialized in western foods. Some restaurants also serve alcoholic beverages with the foods. The differences also lie in the ingredients and recipes of the same foods served in different restaurants. The chefs play a vital part in making different products in this market. Product differentiation is the reason why the market demand curve is elastic. People have a choice regarding choosing any food. Some of the foods are seasonal. The demand for those foods rises in certain seasons only. For example, the demand for the ice cream sold in the restaurants sees the high demand during the summer. On the other hand, the demand falls during winter for ice creams.

Selling costs: The selling costs are different for different restaurants in the industry. The selling cost determines the price the producers should charge with constraints being the market competition. Restaurants with less selling costs can earn more profit in the market. As stated by Schiff (2015), the selling costs differ due to various reasons like location, cost of acquiring resources, the cost of management, cost of adding values to the products, advertising the products, and others. There are two types of costs namely fixed cost and variable cost. The fixed cost is incurred by the producer before the production process starts and the amount remains the same even during the production. The variable cost changes with the change in quantity produced. With more production, the variable cost will increase.

Features of Restaurant Industry

Freedom of entry and exit: The industry possesses the freedom of entry and exit of the producers in the market. In the short run, if a producer is incurring loss he has the opportunity of leaving the market. If the produces faces profit in the short run, they will opt for operating in the market, in the long run as well. Bennelong, Automata, Firedoor, and many other restaurants have recently joined the industry.


The absence of perfect knowledge: The absence of perfect knowledge is one of the reasons the monopolistic competition remains in the industry. If the consumers had perfect knowledge regarding the market and the prices, the restaurants charging higher prices will become inefficient and lose the share of demand it receives. It will also show the customers how much extra they are paying for the services.

Non-price competition: The competition that exists among different restaurants is more quality oriented than price and quantity. Those restaurants serving fresh foods with a better environment and services will face more demand than those with lesser quality. The price of the products is of less significance in the competition.

The behaviour of the restaurants affects the consumers hugely. These impacts are both positive and negative. The pricing policy of the restaurants plays a basic role in affecting the consumers, which is not very significant as the quality of the services matters to the consumers more than the price. The competitive advantage of a restaurant makes a huge impact on the consumers. The strategies taken by the restaurants to gain competitive advantages varies from one restaurant to another. There are strategies like an advertisement, using social media, printing media, and other media to reach the customers. Those restaurants who can reach more customers with more commodity information will face more demand. The marketing strategies taken by the restaurants depend on the leadership styles they are following.

The leaders follow different marketing strategies to introduce the products to the customers. Apart from providing the service with added values, there are many external factors which are to be addressed by the leaders. In the views of Hua, Xiao and Yost (2013), the restaurants can follow aggressive or defensive roles in capturing the market shares. Most of the strategies which are targeted to boost up the images of the restaurants in front of the customers show positive net effects. On the other hand, when the internal traits such as service, quality, and others do not meet the expectations of the consumers who are drawn to the restaurants by the aggressive strategies, negative net affects follow. The demand for the products for those restaurants will fall.

Following the views of Gleeson (2016), the negative externalities that arise from the Adani Group's Carmichael coal mine located in Queensland's Galilee Basin will affect the locals and the environment as well of Queensland. The extraction of coal from the Carmichael coal mine will bring negative effects which will be caused by the huge amount of emission. The extraction of the raw coal and processing is associated huge emission. The local people will be badly affected by this as the whole area will be. As stated by Dröes and Koster (2016), the greenery also takes the hit. The life chain of that place, which includes animals and birds, also gets disrupted. The distribution process will also affect the local environment negatively. But these negative externalities will not be covered by the investors who are rooting for the extraction. The situation can be shown in the figure below.


As shown in the figure above, the yellow area is the total social welfare loss due to the coal extraction. As stated by Heath (2014), the marginal private cost and the marginal private benefits are used in general to find out the quantity that should be extracted and the corresponding price. The price P1 as shown in the figure above does not incorporate the social cost of extraction of the coal. If the social cost were included, the equilibrium would have been at (P2, Q2). Here the quantity is less, and the price incorporates the society's welfare loss. In the views of Kitzmueller and Shimshack (2012), the social loss or the dead weight loss of the society’s welfare occurs when the marginal social cost is greater than the marginal private cost of extracting the coal in Queensland. As the price does not properly reflect the total cost in the scenario, the market failure occurs. The equilibrium which the Adani Group represents shows market inefficiency. To increase the profitability, the company can increase production. It will help the company in achieving the increasing returns to scale. But, with more production, more pollution will be produced.

 The government of Australia can address the negative externalities associated with the market failure. The policies that can be taken by the government to reduce market failures are as follows:

Implementing a tax on negative externalities: The government of Australia can introduce new taxes for the Adani Group's Carmichael coal mine project. According to the ideas given by Rahwan et al. (2012), the negative externalities which are caused by the coal extraction and distribution will be compensated by the amount of tax being paid by the company. The tax structure will depend on the government policies. In the views of Mazzucato and Penna (2015), the government can implement a proportionate tax or a lump sum tax. The proportionate tax will help the government determine how much the company is adding to the social cost. The lump sum tax will not be able to capture the proper amount of the social cost.

Subsidy allocation for positive externalities: The government can provide subsidies to make positive externality creation attractive. This will help the company avoid sacrificing their profit. It will work as an initiative for creating positive externalities. The positive externalities will help the local people to increase their utility. For example, the new project will create new opportunities for skilled and unskilled labours. This will increase the employment in that locality. In the views of Krekel and Zerrahn (2016), the government can make a rule which will clearly state that after extraction process is done; new trees will be planted in the whole extraction site. This will make the environment balanced in Queensland.


Laws and regulations: The government has to create new laws and regulations to reduce the social cost which is the result of market failure. In the views of Pinotti (2012), the government can ensure that the difference between the marginal social cost and the marginal private cost tends to decrease. The laws will be created after estimating the cost to the society. This way the market failure will be reduced as the company will try to ensure that the efficiency is properly achieved.

Pollution permits: The government can start giving pollution permits to control how much a company can produce pollution. In the views of Chasek, Downie and Brown (2013), the negative externalities will decrease as a result. The companies will know beforehand about starting their production process how much they are allowed to produce pollution. It will also help the companies to determine their production strategy. The pollution permit with a certain amount will be given to the Adani Group's Carmichael coal mine project. It will increase their cost of production as the production process will now incorporate the social cost. This way the market failure can be removed from the company.

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.

Chasek, P. S., Downie, D. L., & Brown, J. (2013). Global environmental politics. Westview Press.

Dhingra, S., & Morrow, J. (2012). Monopolistic competition and optimum product diversity under firm heterogeneity. London School of Economics, mimeograph.

Dröes, M. I., & Koster, H. R. (2016). Renewable energy and negative externalities: The effect of wind turbines on house prices. Journal of Urban Economics, 96, 121-141.

Gleeson, M. (2016). Qld gov't to fast track Adani coalmine. Green Left Weekly, (1114), 8.

Heath, J. (2014). Morality, competition, and the firm: The market failures approach to business ethics. Oxford University Press.

Hua, N., Xiao, Q., & Yost, E. (2013). An empirical framework of financial characteristics and outperformance in troubled economic times: evidence from the restaurant industry. International Journal of Contemporary Hospitality Management, 25(6), 945-964.

Kitzmueller, M., & Shimshack, J. (2012). Economic perspectives on corporate social responsibility. Journal of Economic Literature, 50(1), 51-84.

Krekel, C., & Zerrahn, A. (2016). Does the presence of wind turbines have negative externalities for people in their surroundings? Evidence from well-being data. Journal of Environmental Economics and Management.

Lábaj, M., Morvay, K., Silanic, P., Weiss, C., & Yontcheva, B. (2016). Market Structure and Competition in Transition: Results from a Spatial Analysis.

Lee, C., Sardeshmukh, S. R., & Hallak, R. (2015). Innovation as a driver of performance in the Australian restaurant industry. CAUTHE 2015: Rising Tides and Sea Changes: Adaptation and Innovation in Tourism and Hospitality, 224.

Mazzucato, M., & Penna, C. C. (2015). Beyond market failures: The market creating and shaping roles of state investment banks. Levy Economics Institute of Bard College Working Paper, (831).

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

Nocco, A., Ottaviano, G. I., & Salto, M. (2014). Monopolistic competition and optimum product selection. The American Economic Review, 104(5), 304-309.

Osharin, A., Thisse, J. F., Ushchev, P., & Verbus, V. (2014). Monopolistic competition and income dispersion. Economics Letters, 122(2), 348-352.

Parenti, M., Thisse, J. F., & Ushchev, P. (2014). Toward a theory of monopolistic competition.

Pinotti, P. (2012). Trust, regulation and market failures. Review of Economics and Statistics, 94(3), 650-658.

Rahwan, T., Michalak, T., Wooldridge, M., & Jennings, N. R. (2012). Anytime coalition structure generation in multi-agent systems with positive or negative externalities. Artificial Intelligence, 186, 95-122.

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

Rubinstein, A. (2012). Lecture notes in microeconomic theory: the economic agent. Princeton University Press.

Sacks, G., Mialon, M., Vandevijvere, S., Trevena, H., Snowdon, W., Crino, M., & Swinburn, B. (2015). Comparison of food industry policies and commitments on marketing to children and product (re) formulation in Australia, New Zealand and Fiji. Critical Public Health, 25(3), 299-319.

Schiff, N. (2015). Cities and product variety: evidence from restaurants. Journal of Economic Geography, 15(6), 1085-1123.

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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