The Theory of Monopolistic competition

The theory of Monopolistic competition was first introduced in 1930 by American Economist Prof. Edward Chamberlin, which was planned on the basis of mixture of competitive and monopolistic theories. He suggests that “to consider the theory of monopolistic competition vaguely as a theory of imperfect competition is to confuse the issues”(www.transtutors.com). The monopolistic competition can also be considered as a foremost type of imperfect competition.

MONOPOLISTIC COMPETITION:

Monopolistic competition is that market structure which is specified by large number of small firms and there is intense contest between large number of suppliers and producers, the goods sold by all the firms are quite same but they are not equal, ample information on prices and technology, with comparative freedom of entry into and way out of the industry. They have some amount of monopoly because of their different types of products. Hence it is a mixture of some amount of monopoly influence and perfect competition. The examples of monopolistic competition are restaurants, clothing stores, retail stores and apartments.

Monopolistic competition in the short run :

In the short run under monopolistic competition the profit is maximised by a company and manufactures products to an extent when the company’s marginal cost(MC) is equal to marginal revenue(MR). In the above diagram there is downward sloping of demand curve because the price of all the units are not similar as in the case of perfect competition where average revenue(AR) is equivalent to price. On the basis of the average cost(AC) and average revenue(AR) curve the profit is gained by the company.

Monopolistic Competition in the Long Run :

In the long run under monopolistic competition both entry and exit are possible for the firms. The supply of distinguished products will rise with the entry of new firms which causes the firm’s demand curve to shift left. When there will be more entry of firms in the market the demand curve will continue shifting towards the left as there will be more competition among the firms. No longer will an economic profit be claimed by the firms. Thus in the long run under monopolistic competition each firm will earn normal profit due to the competition brought with the entry of new firms.

The market for mp3 player as an example of Monopolistic Competition :

In a monopolistic competition there is freedom of entry into and way out of the industry likewise there are no barriers for entry and exit in the mp3 market. There are many sellers in the mp3 player market and an intense competition goes on between them. They compete with each other on the basis of price and the quality of their products without affecting the market place.

In the short run the market for mp3 player was taken by Apple iPod as they were the first entrants and no competitors were there. The total economic profit was gained by them.

But in the long run many new firms together with the mobile phone producers enters the mp3 market which causes the demand curve to shift towards left and zero economic profit is earned by every firms. Each of them produces their own products which are slightly different from the others. They compete with each other on the basis of price and quality.

It can be argued on the basis that few other firms are dominating the market of mp3 players like Apple, Microsoft and Sony, but as there is no interdependence on prices there is no oligopoly. As a result the market of mp3 player can be considered as an example of monopolistic competition.

The effects on the Apple Ipod of increased competition from other firms successfully entering the market :

In the year 2001 Apple introduced its first iPod in the market. By the year 2006 various other firms like Microsoft and mobile phone companies entered the market of mp3 and gave apple some competition. In order to stay in the contest Apple frequently reorganized the iPod.

In figure 1, the graph shows the conditions that were faced by Apple in the year 2005. The Marginal Curve for the Apple iPod is MC and the Average total Cost Curve is ATC. The Marginal Revenue curve for the Apple iPod is MR and the demand curve is D. At that time the apple iPod had kept the contest with other mp3 players aside as there was no other player to compete with them.

In the year 2006, many new firms together with the mobile phone producers made a successful entry into the mp3 market. Every firms produces mp3 players which are little different from others. On the basis of price, quality and marketing the firms contend with each other. The demand of the Apple iPod becomes elastic as the entry of other mp3 players decreases the demand of Apple iPod.

In figure 2 the graph shows the condition of Apple iPod after the successful entry of other firms. Here also the average total cost of Apple iPod is LRAC and the marginal cost is LRMC. The Marginal Revenue Curve has shifted to MR˪ and the Demand Curve has shifted to D˪. As both the price and the average total cost are identical so zero economic profit is earned on Apple iPods. Therefore the sale of apple iPods decreases up to some extent after the entry of other firms.

Conclusion :

In conclusion after analysing the market for mp3 players it is seen that in the short run the market for mp3 player there is some amount of monopoly as Apple was the only producer of iPods but after few years other new firms came into the mp3 market which resulted in the decrease in sales of apple iPods. As a result in the long run zero economic profit was shared by every firms. Because of the competition apple again modifies its product and brings new apple iPod video in the market. Once again Apple returns to the first condition as there was no other video players to compete with them but it didn’t last long soon other firms together with the mobile phone producers makes an entry into the market with video capability and again the economic profit earned by every firm becomes zero.