Chapter 17, Problem 1SPPA

To determine

Examples of monopolistic competition are to be determined.

Explanation of Solution

Monopolistic competition lies between the two extreme market structures. These markets neither have very large number of sellers akin to perfect competition, nor are they characterized by a single seller as in a monopoly. The firms have a small market share in that each firm is able to influence its own price but not the market price.

Differentiation in the products sold by the firms is a typical feature of this market. By differentiating the products, firms use different packaging, product design and add other features to the products. This makes the product a close substitute to others but not a perfect substitute unlike the products sold in perfect competition.

Another significant difference is the selling cost or the cost incurred on marketing and advertising. Firms spend a large sum of money in promotion of product to signal the consumers about its quality Advertising is expected to increase the sales for both low quality and high quality products.

There are no restrictions on the entry and exit of the firms so that no single firm is able to earn a long run economic profit. Markets that compete in monopolistic competition have a lower value of four-firm concentration ratio, around 40 percent. The HHI value for these markets is less than 2,500.

Market for cable television is not served by a large number of sellers. In addition, there are significant entry barriers in terms of huge start-up costs in setting up the transmission network. Hence, cable television services are not monopolistically competitive.

Wheat is sold in perfectly competitive market. The reason is that each farmer sells an insignificant share in the market and cannot charge a price higher than the prevailing price. There is no advertising cost to promote the sales of wheat. Hence, wheat market is not a monopolistically competitive market.

The production of athletic shoes does not require a huge start-up cost so that entry and exit is costless. There are large number of firms selling athletic shoes with each firm doing a profound research on product design and performance. Hence products are highly differentiated, yet they are close substitutes. In this sense, market for athletic shoes is a monopolistically competitive market

There is no product differentiation in soda sold in the soda market. Firms do not spend large sum of money on advertising and there are neither large number of sellers. Hence, soda market is not monopolistically competitive.

Economics Concept Introduction

Monopolistic Competition:

It is defined as a market structure which is a combination of competitive markets and monopoly.

Monopolistic competitive industry is where there are many firms, there is freedom of exit and entry, firms produce the products that are differentiated, and they are regarded as the price makers as they have differentiated products, the firms generate normal profits in long run and the firms are productively and allocatively inefficient.