Monopolistic Competition

Monopolistic Competition
 
Monopolistic competition is a type of imperfect competition such that many producers sell products that are differentiated from one another (e.g. by branding or quality) and hence are not perfect substitutes. In monopolistic competition, a firm takes the prices charged by its rivals as given and ignores the impact of its own prices on the prices of other firms.^[1][2] In the presence of coercive government, monopolistic competition will fall into government-granted monopoly. Unlike perfect competition, the firm maintains spare capacity. Models of monopolistic competition are often used to model industries. Textbook examples of industries with market structures similar to monopolistic competition include restaurants, cereal, clothing, shoes, and service industries in large cities. The "founding father" of the theory of monopolistic competition is Edward Hastings Chamberlin, who wrote a pioneering book on the subject, Theory of Monopolistic Competition (1933).^[3] Joan Robinson published a book The Economics of Imperfect Competition with a comparable theme of distinguishing perfect from imperfect competition.
Monopolistically competitive markets have the following characteristics:

• There are many producers and many consumers in the market, and no business has total control over the market price.
• Consumers perceive that there are non-price differences among the competitors' products.
• There are few barriers to entry and exit.^[4]
• Producers have a degree of control over price.

The long-run characteristics of a monopolistically competitive market are almost the same as a perfectly competitive market. Two differences between the two are that monopolistic competition produces heterogeneous products and that monopolistic competition involves a great deal of non-price competition, which is based on subtle product differentiation. A firm making profits in the short run will nonetheless only break even in the long run because demand will decrease and average total cost will increase. This means in the long run, a monopolistically competitive firm will make zero economic profit. This illustrates the amount of influence the firm has over the market; because of brand loyalty, it can raise its prices without losing all of its customers. This means that an individual firm's demand curve is downward sloping, in contrast to perfect competition, which has a perfectly elastic demand schedule.

Major characteristics

There are six characteristics of monopolistic competition (MC):

• Product differentiation
• Many firms
• No entry and exit cost in the long run
• Independent decision making
• Some degree of market power
• Buyers and Sellers do not have perfect information (Imperfect Information)^[5][6]

MC firms sell products that have real or perceived non-price differences. However, the differences are not so great as to eliminate other goods as substitutes. Technically, the cross price elasticity of demand between goods in such a market is positive. In fact, the XED would be high.^[7] MC goods are best described as close but imperfect substitutes.^[7] The goods perform the same basic functions but have differences in qualities such as type, style, quality, reputation, appearance, and location that tend to distinguish them from each other. For example, the basic function of motor vehicles is the same—to move people and objects from point to point in reasonable comfort and safety. Yet there are many different types of motor vehicles such as motor scooters, motor cycles, trucks and cars, and many variations even within these categories.

Monopoly

Monopoly

A monopoly (from Greek monos μόνος (alone or single) + polein πωλεῖν (to sell)) exists when a specific person or enterprise is the only supplier of a particular commodity (this contrasts with a monopsony which relates to a single entity's control of a market to purchase a good or service, and with oligopoly which consists of a few entities dominating an industry).^[2] Monopolies are thus characterized by a lack of economic competition to produce the good or service and a lack of viable substitute goods.^[3] The verb "monopolise" refers to the process by which a company gains the ability to raise prices or exclude competitors. In economics, a monopoly is a single seller. In law, a monopoly is a business entity that has significant market power, that is, the power to charge high prices.^[4] Although monopolies may be big businesses, size is not a characteristic of a monopoly. A small business may still have the power to raise prices in a small industry (or market).^[4]
A monopoly is distinguished from a monopsony, in which there is only one buyer of a product or service; a monopoly may also have monopsony control of a sector of a market. Likewise, a monopoly should be distinguished from a cartel (a form of oligopoly), in which several providers act together to coordinate services, prices or sale of goods. Monopolies, monopsonies and oligopolies are all situations such that one or a few of the entities have market power and therefore interact with their customers (monopoly), suppliers (monopsony) and the other companies (oligopoly) in ways that leave market interactions distorted.^{[citation needed]}
Monopolies can be established by a government, form naturally, or form by integration.
In many jurisdictions, competition laws restrict monopolies. Holding a dominant position or a monopoly of a market is often not illegal in itself, however certain categories of behavior can be considered abusive and therefore incur legal sanctions when business is dominant. A government-granted monopoly or legal monopoly, by contrast, is sanctioned by the state, often to provide an incentive to invest in a risky venture or enrich a domestic interest group. Patents, copyright, and trademarks are sometimes used as examples of government granted monopolies. The government may also reserve the venture for itself, thus forming a government monopoly.^{[citation needed]}

Market structures

In economics, the idea of monopoly will be important for the study of management structures, which directly concerns normative aspects of economic competition, and provides the basis for topics such as industrial organization and economics of regulation. There are four basic types of market structures by traditional economic analysis: perfect competition, monopolistic competition, oligopoly and monopoly. A monopoly is a structure in which a single supplier produces and sells a given product. If there is a single seller in a certain industry and there are not any close substitutes for the product, then the market structure is that of a "pure monopoly". Sometimes, there are many sellers in an industry and/or there exist many close substitutes for the goods being produced, but nevertheless companies retain some market power. This is termed monopolistic competition, whereas by oligopoly the companies interact strategically.^{[citation needed]}
In general, the main results from this theory compare price-fixing methods across market structures, analyze the effect of a certain structure on welfare, and vary technological/demand assumptions in order to assess the consequences for an abstract model of society. Most economic textbooks follow the practice of carefully explaining the perfect competition model. The boundaries of what constitutes a market and what doesn't are relevant distinctions to make in economic analysis. In a general equilibrium context, a good is a specific concept entangling geographical and time-related characteristics (grapes sold during October 2009 in Moscow is a different good from grapes sold during October 2009 in New York). Most studies of market structure relax a little their definition of a good, allowing for more flexibility at the identification of substitute-goods. Therefore, one can find an economic analysis of the market of grapes in Russia, for example, which is not a market in the strict sense of general equilibrium theory monopoly.^{[citation needed]} understand "departures" from it (the so-called imperfect competition models).^{[citation needed]}

Characteristics

• Profit Maximizer: Maximizes profits.
• Price Maker: Decides the price of the good or product to be sold, but does so by determining the quantity in order to demand the price desired by the firm.
• High Barriers: Other sellers are unable to enter the market of the monopoly.
• Single seller: In a monopoly, there is one seller of the good that produces all the output.^[5] Therefore, the whole market is being served by a single company, and for practical purposes, the company is the same as the industry.
• Price Discrimination: A monopolist can change the price and quality of the product. He or she sells higher quantities, charging a lower price for the product, in a very elastic market and sells lower quantities, charging a higher price, in a less elastic market.

Price discrimination

Price discrimination

Price discrimination or price differentiation is a pricing strategy where identical or largely similar goods or services are transacted at different prices by the same provider in different markets or territories.^[1][2][3] Price differentiation is distinguished from product differentiation by the more substantial difference in production cost for the differently priced products involved in the latter strategy.^[3] Price differentiation essentially relies on the variation in the customers' willingness to pay.^[2][3]
The term differential pricing is also used to describe the practice of charging different prices to different buyers for the same quality and quantity of a product,^[4] but it can also refer to a combination of price differentiation and product differentiation.^[3] Other terms used to refer to price discrimination include equity pricing, preferential pricing,^[5] and tiered pricing.^[6] Within the broader domain of price differentiation, a commonly accepted classification dating to the 1920s is:^[7][8]

• Personalized pricing (or first-degree price differentiation) — selling to each customer at a different price; this is also called one-to-one marketing.^[7] The optimal incarnation of this is called perfect price discrimination and maximizes the price that each customer is willing to pay,^[7] although it is extremely difficult to achieve in practice^[7] because a means of determining the precise willingness to pay of each customer has not yet been developed.
• Group pricing (or third-degree price differentiation) — dividing the market in segments and charging the same price for everyone in each segment^[7][9] This is essentially a heuristic approximation that simplifies the problem in face of the difficulties with personalized pricing.^[8][10] A typical example is student discounts.^[9]
• Product versioning^[2][11] or simply versioning (or second-degree price differentiation) — offering a product line^[7] by creating slightly different products for the purpose of price differentiation,^[2][11] i.e. a vertical product line.^[12] Another name given to versioning is menu pricing.^[8][13]
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  Types of price discrimination

  First degree price discrimination

  This type of price discrimination requires the monopoly seller of a good or service to know the absolute maximum price (or reservation price) that every consumer is willing to pay. By knowing the reservation price, the seller is able to sell the good or service to each consumer at the maximum price he is willing to pay, and thus transform the consumer surplus into revenues. So the profit is equal to the sum of consumer surplus and producer surplus. The marginal consumer is the one whose reservation price equals to the marginal cost of the product. The seller produces more of his product than he would to achieve monopoly profits with no price discrimination, which means that there is no deadweight loss. Examples of where this might be observed are in markets where consumers bid for tenders, though, in this case, the practice of collusive tendering could reduce the market efficiency.^[15]
  

  Second degree price discrimination

  In second degree price discrimination, price varies according to quantity demanded. Larger quantities are available at a lower unit price. This is particularly widespread in sales to industrial customers, where bulk buyers enjoy higher discounts.^[16]
  Additionally to second degree price discrimination, sellers are not able to differentiate between different types of consumers. Thus, the suppliers will provide incentives for the consumers to differentiate themselves according to preference. As above, quantity "discounts", or non-linear pricing, is a means by which suppliers use consumer preference to distinguish classes of consumers. This allows the supplier to set different prices to the different groups and capture a larger portion of the total market surplus.
  In reality, different pricing may apply to differences in product quality as well as quantity. For example, airlines often offer multiple classes of seats on flights, such as first class and economy class. This is a way to differentiate consumers based on preference, and therefore allows the airline to capture more consumer's surplus.
  

  Third degree price discrimination

  In third degree price discrimination, price varies by attributes such as location^[17] or by customer segment, or in the most extreme case, by the individual customer's identity; where the attribute in question is used as a proxy for ability/willingness to pay.
  

  Combination

  These types are not mutually exclusive. Thus a company may vary pricing by location, but then offer bulk discounts as well. Airlines use several different types of price discrimination, including:
  
• Bulk discounts to wholesalers, consolidators, and tour operators
• Incentive discounts for higher sales volumes to travel agents and corporate buyers
• Seasonal discounts, incentive discounts, and even general prices that vary by location. The price of a flight from say, Singapore to Beijing can vary widely if one buys the ticket in Singapore compared to Beijing (or New York or Tokyo or elsewhere).
• Discounted tickets requiring advance purchase and/or Saturday stays. Both restrictions have the effect of excluding business travelers, who typically travel during the workweek and arrange trips on shorter notice.
• First degree price discrimination based on customer. It is not accidental that hotel or car rental firms may quote higher prices to their loyalty program's top tier members than to the general public.^{[citation needed]}

Modern taxonomy

The first/second/third degree taxonomy of price discrimination is due to Pigou (Economics of Welfare, 4th edition, 1932). See, e.g., modern taxonomy of price discrimination. However, these categories are not mutually exclusive or exhaustive. Ivan Png (Managerial Economics, 2nd edition, 2002) suggests an alternative taxonomy:

• Complete discrimination -- where each user purchases up to the point where the user's marginal benefit equals the marginal cost of the item;
• Direct segmentation -- where the seller can condition price on some attribute (like age or gender) that directly segments the buyers;
• Indirect segmentation -- where the seller relies on some proxy (e.g., package size, usage quantity, coupon) to structure a choice that indirectly segments the buyers.

The hierarchy—complete/direct/indirect—is in decreasing order of

• profitability and
• information requirement.

Complete price discrimination is most profitable, and requires the seller to have the most information about buyers. Indirect segmentation is least profitable, and requires the seller to have the least information about buyers.

Two part tariff

The two-part tariff is another form of price discrimination where the producer charges an initial fee then a secondary fee for the use of the product. An example of this is razors, you pay an initial cost for the razor and then pay for the replacement blades. This pricing strategy works because it shifts the demand curve to the right: since you have already paid for the initial blade holder you will buy the blades which are now cheaper than buying a disposable razor.