How many sellers are in a monopolistic market

Monopolistic competition characterizes an industry in which many firms offer products or services that are similar but not perfect substitutes. Barriers to entry and exit in a monopolistic competitive industry are low, and the decisions of any one firm do not directly affect those of its competitors. Monopolistic competition is closely related to the business strategy of brand differentiation.

Monopolistic competition is a middle ground between monopoly and perfect competition a purely theoretical state and combines elements of each. All firms in monopolistic competition have the same relatively low degree of market power; they are all price makers. In the long run, demand is highly elastic, meaning that it is sensitive to price changes. In the short run, economic profit is positive, but it approaches zero in the long run.

Firms in monopolistic competition tend to advertise heavily. Monopolistic competition is characterized by heavy spending on advertising and marketing, which some economists characterize as a waste of resources. Monopolistic competition is a form of competition that characterizes a number of industries that are familiar to consumers in their day-to-day lives. Examples include restaurants, hair salons, clothing, and consumer electronics.

To illustrate the characteristics of monopolistic competition, we'll use the example of household cleaning products. Say you've just moved into a new house and want to stock up on cleaning supplies. Go to the appropriate aisle in a grocery store, and you'll see that any given item—dish soap, hand soap, laundry detergent, surface disinfectant, toilet bowl cleaner, etc. For each purchase you need to make, perhaps five or six firms will be competing for your business. Because the products all serve the same purpose, there are relatively few options for sellers to differentiate their offerings from other competing firms.

There might be "discount" varieties that are of lower quality, but it is difficult to tell whether the higher-priced options are in fact any better. This uncertainty results from imperfect information: the average consumer does not know the precise differences between the various products, or what the fair price for any of them is. Monopolistic competition tends to lead to heavy marketing because different firms need to distinguish broadly similar products.

One company might opt to lower the price of their cleaning product, sacrificing a higher profit margin in exchange—ideally—for higher sales. Another might take the opposite route, raising the price and using packaging that suggests quality and sophistication. A third might sell itself as more eco-friendly, using "green" imagery and displaying a stamp of approval from an environmental certifier.

In reality, every one of the brands might be equally effective. Hair salons, restaurants, clothing, and consumer electronics are all examples of industries with monopolistic competition. Each company offers products that are similar to others in the same industry. Collusion, or the cooperative outcome, could result in monopoly profits. In the USA, explicit collusion is illegal. For example, if gas stations in a city such as Manhattan, Kansas all matched a higher price, they could all make more money.

However, there is an incentive to cheat on this implicit agreement by cutting the price and attracting more customers away from the other firms to your own gas station.

Firms in a cooperative agreement are always tempted to break the agreement to do better. The Nash Equilibrium calculated for the three oligopoly models Cournot, Bertand, and Stackelberg is a noncooperative equilibrium, as the firms are rivals and do not collude. In these models, firms maximize profits given the actions of their rivals.

This is common, since collusion is illegal and price wars are costly. Oligopolists have a strong desire for price stability. Firms in oligopolies are reluctant to change prices, for fear of a price war.

If a single firm lowers its price, it could lead to the Bertrand equilibrium, where price is equal to marginal costs, and economic profits are equal to zero. The kinked demand model asserts that a firm will have an asymmetric reaction to price changes. Rival firms in the industry will react differently to a price change, which results in different elasticities for price increases and price decreases.

The kinked demand curve is shown in Figure 5. In the kinked demand curve model, MR is discontinuous, due to the asymmetric nature of the demand curve. For linear demand curves, MR has the same y-intercept and two times the slope… resulting in two different sections for the MR curve when demand has a kink. The graph shows how price rigidity occurs: any changes in marginal cost result in the same price and quantity in the kinked demand curve model.

As long as the MC curve stays between the two sections of the MR curve, the optimal price and quantity will remain the same. One important feature of the kinked demand model is that the model describes price rigidity, but does not explain it with a formal, profit-maximizing model. The kinked demand model is criticized because it is not based on profit-maximizing foundations, as the other oligopoly models. Price signaling is common for gas stations and grocery stores, where price are posted publically.

A dominant firm is defined as a firm with a large share of total sales that sets a price to maximize profits, taking into account the supply response of smaller firms. The dominant firm model is also known as the price leadership model.

The market demand for the good D mkt is equal to the sum of the demand facing the dominant firm D dom and the demand facing the fringe firms D F. Total quantity Q T is also the sum of output produced by the dominant and fringe firms. The dominant firm model is shown in Figure 5. The supply curve for the fringe firms is given by S F , and the marginal cost of the dominant firm is MC dom. The dominant firm has the advantage of lower costs due to economies of scale.

In what follows, the dominant firm will set a price, allow the fringe firms to produce as much as they desire, and then find the profit-maximizing quantity and price with the remainder of the market. To find the profit-maximizing level of output, the dominant firm first finds the demand curve facing the dominant firm the dashed line in Figure 5. The dominant firm demand curve is found by the following procedure. At this point, the fringe firms supply the entire market, so the residual facing the dominant firm is equal to zero.

Therefore, the demand curve of the dominant firm starts at the price where fringe supply equals market demand. The second point on the dominant firm demand curve is found at the y-intercept of the fringe supply curve S F. At any price equal to or below this point, the supply of the fringe firms is equal to zero, since the supply curve represents the cost of production. At this point, and all prices below this point, the market demand D mkt is equal to the dominant firm demand D dom.

Thus, the dashed line below the y-intercept of the fringe supply is equal to the market demand curve. This is the dashed line above the S F y-intercept. Once the dominant firm demand curve is identified, the dominant firm maximizes profits by setting marginal revenue equal to marginal cost at quantity Q dom.

This level of output is then substituted into the dominant firm demand curve to find the price P dom. The fringe firms take this price as given, and produce Q F.

In this way, the dominant firm takes into account the reaction of the fringe firms while making the output decision. The model effectively captures an industry with one dominant firm and many smaller firms. A cartel is a group of firms that have an explicit agreement to reduce output in order to increase the price. Cartels are illegal in the United States, as the cartel is a form of collusion.

The success of the cartel depends upon two things: 1 how well the firms cooperate, and 2 the potential for monopoly power inelastic demand. Cooperation among cartel members is limited by the temptation to cheat on the agreement. This cartel is legal, since it is an international agreement, outside of the American legal system. Frequently, one or more member nations increases oil production above the agreement, putting downward pressure on oil prices.

A collusive agreement, or cartel, results in a circular flow of incentives and behavior. When firms in the same industry act independently, they each have an incentive to collude, or cooperate, to achieve higher levels of profits. If the firms can jointly set the monopoly output, they can share monopoly profit levels.

When firms act together, there is a strong incentive to cheat on the agreement, to make higher individual firm profits at the expense of the other members. The business world is competitive, and as a result oligopolistic firms will strive to hold collusive agreements together, when possible. This type of strategic decisions can be usefully understood with game theory, the subject of the next two Chapters.

Skip to content Main Body. Monopolistic Competition. Homogeneous good. Numerous firms. The idea behind monopolistic competition is simple in form and powerful in practice. Monopolistic competition involves many buyers, many sellers, and easy exit and entry, with slightly differentiated products. The sellers in these markets sell products that are closely related, but not identical. They have features that differentiate them from the competition.

Usually, the buyers and sellers also have good information on the attributes of the products and the prices of the products in the marketplace. Indeed, most products and services are sold in markets characterized by monopolistic competition. The list includes jewelry, movie production, food, entertainment, many electronic gadgets and components, some durable goods, books, crafts, soda, houses, cars, consulting businesses, software, game consoles, restaurants, bars, and so forth.

Whilst monopoly and perfect competition are at completely different ends of the spectrum; monopolistic competition is somewhere in between. It is similar to a monopoly in the fact a firm can make supernormal profits in the short-term. Yet at the same time, there is easy market entry and exit, with few barriers to entry : similar to perfect competition.

In short, monopolistic competition is a market structure where many competitors sell slightly different products. In turn, they compete on factors other than price; such as quality, and reliability. Similar to perfect competition, there are many buyers and sellers in the market. However, there are fewer in Monopolistic Competition.

Consumers have a wide variety of choices which is not offered by other market structures such as a monopoly or oligopoly. Firms that operate in a monopolistic market have very similar products but are slightly differentiated to add value over the competition.

Clothing markets are a prime example. There are many types of clothes, each with a slightly different style. This differentiation can be seen in four ways: Physical, Marketing, Human capital , and differentiation through distribution.

Firms in a monopolistic market seek to maximize profit. In economics, this is where marginal costs equal marginal revenue. By doing so, the firm produces right up to the point whereby it becomes unprofitable to produce any more goods. To produce any further would create a loss for the firm. So up to this point, the firm is making a profit on producing an additional unit to sell.

New entrants are easily able to enter as there are none or very insignificant barriers to entry. The cost to start a new business is low and the risk involved in failing is also comparatively low. So the incentive to enter the market is high, whilst few tools are needed. In other words, there are many more people who are able and willing to compete.

Monopolistic firms can make supernormal profits if they can benefit from a gap in the market. Looking at clothing, for example, one company may create a new design that has never been done before. If it goes down a hit with the customers, the firm benefits from high levels of demand. These lead to supernormal profits in the short-term until other firms become aware. They then try to make similar products, thereby reducing the level of profits of the original firm. Over the long-term, profits shrink as new entrants enter the market to compete.

Due to low barriers to entry, new firms can see any supernormal profits that are made and come in to take their share. So whilst some firms may benefit from new products in the short-term, these supernormal profits are brought back down again with the introduction of competition. In perfect competition, the customer is able to gather information relatively easily as all products are the same.

At the same time, the cost to gather information in a monopoly structure is relatively low as there is only one firm. By contrast, in monopolistic competition, many firms offer slightly different products — which makes information gathering more time consuming and costly.

Insurance is a prime example — which is why a number of comparison sites have come into existence. This can come through shorter wait times or more attentive employees. Local taxi firms seek to differentiate themselves through factors such as pre-bookings, limousine service, or through a fleet of different cars.

There are many firms in the market, yet cannot be considered perfectly competition due to: levels of differentiation, imperfect information on drivers, and the ability to make supernormal profits during peak periods.