8. Monopolistic competition Contents * industry features * firm´s equilibrium in short run and long run * Chamberlin model * product differentiation model * monopolistic competition efficiency Monopolistic competition features * the „mildest“ form of imperfect competition * many firms in the industry * production in the industry: close substitutes, but: * ...partial differentiation * includes features either of monopoly and perfect competition * examples: retail, pubs, accommodation etc. •Perfect competition features: * minimal barriers to enter/leave the industry... * ...LR tendency to zero economic profit •Monopolistic features: * specific firm is able to set its equilibrium price above its MC function – firm is a price maker Monopolistic competition features Product differentiation * Location of business premises, wrapers, services etc. consumers´ willingness to pay different prices for similar goods supplied by different firms * why are the pubs in the centre cheaper than on the edge of the town? * why do you pay higher price for accommodation in a hotel at the slope-site than in a hotel off the slope-site? Industry identification •2 indices: * Four-firm concentration ratio * Herfindahl-Hirschman index Four-firm concentration ratio * we measure the market share of 4 biggest firms in the industry * 0 – 100 % * if close to zero – perfect competition * 100 % - monopoly * 40 – 100 % - oligopoly * to 40 % - monopolistic competition Herfindahl-Hirschman index (HHI) * a sum of squares of firms´ market shares * i.e. if 4 firms in the industry with shares: 50%, 25%, 15%, 10 %, then: * HHI = 0,52 + 0,252 + 0,152 +0,12 = 0,345 * if HHI ≤ 0,1 – competitive industry * if 0,1 ≤ HHI ≤ 0,18 – semi-competitive industry * if HHI ≥ 0,18 – concentrated industry HHI of banking sector in the Czech Republic Zdroj: Chmelík, J.:České bankovnictví v letech 1990 – 1996. HHI development in 1990 - 1996 Balance sum Loan volume Deposits Equity 0,45 0,4 0,35 0,3 0,25 0,2 0,15 0,1 0,05 Firm´s short run equilibrium •SMC = MR CZK/Q Q AR = d SMC MR SAC Q* P* firm´s profit In short run it is possible to gain the positive economic profit Firm´s shut down point in the short run •firm shuts down if: P ≤ AVC CZK/Q Q AR = d SMC MR SAC Q* P* AVC firm´s loss firm´s short run shut down point Firm´s long run equilibrium * minimal barriers to enter/leave the industry→ LR tendency to zero economic profit * profitable industry motivates other firms to enter – individual demands decrease, equilibrium price decreases, profit decreases (to zero) * loss-making industry motivates to leave – individual demands increase, equilibrium price increases, loss decreases (to zero) * LR firm´s equilibrium: LAC = AR = P Firm´s LR equilibrium •LMC = MR = AR = LAC CZK/Q Q AR1 = d1 LMC MR1 SAC Q*SR P*SR firm´s profit LAC AR2 = d2 MR2 Q*LR P*LR profitable industry induces the influx of other firms → individual demand of the specific firm decreases LR equilibrium: LAC = AR = P → each firm in the industry gains zero economic profit Chamberlin model of monopolistic competition •ASSUMPTIONS: 1.Many firms in the industry (similar but differentiated production) 2.Firms´ behaviour is independent on each other 3.Cost and demand functions of all firms in the industry are equal Chamberlin model •two types of individual demand curves: CZK/Q Q d Q* P* d – assumes: if the specific firm changes its equilibrium price, other firms would not follow – „d“ more elastic D D – assumes: if the specific firm changes its equilibrium price, other firms would follow – „D“ less elastic P1 Q1 Q2 Chamberlin model CZK/Q Q d Q* P* D P1 Q1 Q2 The „d“ curve is an expected firm´s individual demand curve The „D“ curve is the real firm´s individual demand curve equilibrium output is derived from the expected demand curve (firm does not know its real individual demand) Chamberlin model – equilibrium formation CZK/Q Q d1 D P1 Qd1 QD1 MR1 MC firm derives its equilibrium from intersection of MC and MR1 – produces output Qd1 for price P1 in fact, for price P1 consumers demand output QD1 firm decreases its individual demand to d2 and derives its new equilibrium d2 Chamberlin model – equilibrium CZK/Q Q D P* Q* MRn MC dn The firm rearranges its individual demand until its expected equilibrium output and price equals to the real individual demand Q* → Qd = QD Chamberlin model – LR equilibrium CZK/Q Q D P* Q* MR LMC d = AR LAC Chamberln LR equilibrium, fi: Qd = QD plus LAC = AR Product differentiation model * explains the level of product differentiation * explains the willingness of each firm to differ its production from the other firms´ * i.e. premise placement, structure of TV programme, programmes of political parties, etc. Example: placement of beverage-stands * situation: side-walk alongside the beach * problem: where to place the beverage-stand? * ...spot that minimizes the distance to the potential customers * if 2 stands (duopoly): 1st stand into the ¼ of the side-walk, 2nd stand into the ¾ of the side-walk: Initial placement of the beverage-stands walk-side C-C P C-C = Coca-Cola stand P = Pepsi stand Each stand serves its market share... its customer who are at the closest distance, but: Will the stands remain on their positions? Final placement of the stands side-walk C-C P Coca-Cola: „if I move my stand to the middle, I would not lose my left-hand customers, but I can serve some customers of Pepsi.“ Pepsi: „if I move my stand to the middle, I would not lose my right-hand customers, but I can serve some customers of Coca-Cola.“ Both stands move to the middle of the side-walk Conclusions * if there is an oligopolistic market, firms would not differ their production much * the aim is to acquire some of the share of the other firm (firms) But in the case of monopolistic competition * many beverage-stands: Coca-Cola, Pepsi, Kofola, RC-Cola, Tesco Cola etc. * firms are endeavour the maximal differentiation * firms endeavour to convince the customers of the uniqueness of their production * stands try to maximize their distance to the other stand side-walk Application * why the automobile brands copy their production? * ...and why the pubs try to differ their output? * why do we find McD and KFC almost at the same place? * ...and why don´t we find all pharmacies in the city at the central square? Monopolistic competition efficiency •Productive efficiency – firm does not produce its equilibrium output with minimal AC – neither in LR • •Allocative efficiency – DWL exists