There are a small number of market structures that are commonly present in countries around the world. In Market structure Topic 1: Monopolistic competition, we shall examine the characteristics of competition within such a market. Monopolistic competition is very common around the world. Competition is strong, and the ability of firms to operate efficiently in their supply and demand and pricing (among the factors) will determine their survival. In essence, monopolistic competition is where many firms compete in a market with similar products and they seek to differentiate, for example, laundry washing powder or hand soap markets.
Welcome to Topic 5: Monopolistic Competition. In this topic, you will learn about:
- Characteristics of monopolistic competition
- Monopolistically competitive industries
- Monopolistic competition behaviour
- Marginal revenue and marginal cost.
These relate to the Subject Learning Outcomes:
- Understand the microeconomic models to consider fundamental economic choices for households and firms.
- Interpret economic models, diagrams and tables to describe the economic situations.
- Explain how government policy influences microeconomic choices and macroeconomic outcomes.
Welcome to your pre-seminar learning tasks for this week. To be prepared to learn about economic market structures and go well beyond supply and demand please ensure you complete these prior to attending your scheduled seminar with your lecturer.
Click on each of the following headings to read more about what is required for each of your pre-seminar learning tasks.
Read Chapter 16 of the prescribed text – Mankiw, NG 2016, Principles of microeconomics, 8th edn., Cengage Learning Custom Publishing.
Read Chapter 10, Greenlaw, SA & Shapiro, D 2017, Principles of economics 2e, 2nd edn., OpenStax.
Watch this video by Lobsey, S 2013, Marginal cost and marginal revenue, streaming video, YouTube.
The following learning task will be discussed during the scheduled seminar. Please ensure you have completed this task and are ready to discuss your answers with your lecturer and peers.
Most consumers make many regular monopolistic competition purchases. As a consumer, identify two (2) different products you regularly buy/use (at least monthly) that are in a monopolistic competition market. Then, consider the following questions and be prepared to discuss in the seminar with the lecturer.
- Which brand and type of product do you buy?
- What is it about that product in that market that determined your choice?
- To what extent do you often consider the similar products also offered in the monopolistic competition market?
Read the following content.
Market structures
There are several market structures in which firms can operate. The type of structure influences the firm’s behaviour, the level of profits it can generate and whether it is efficient. There can be instances of firms that are profitable but inefficient. Different markets can have different impacts on efficiency due to the nature of competition.
Economic theory (Dean et al. 2017; Mankiw 2018) distinguishes several market structures, each with its own characteristics and assumptions. Therefore, it is helpful, if not essential, to outline how several types of market structures compare to each other before diving deeper into monopolistic competition. This will help understand where one type stops and the next type starts.
They are somewhat on a continuum, from having just one supplier as a monopoly market structure to unlimited suppliers in what is known as perfect competition market structure. However, the number of suppliers is one, but not the only, important element. To understand monopolistic competition, we need to see where it sits in a continuum, right between monopoly and oligopoly (which will be covered in a future topic).
It is important to note, whilst some of these market structures sound very similar, they mean different things. So, pay close attention to each word in the key terms. We will cover monopolistic competition then oligopoly market structures as far as our scope in this subject. The following figure illustrates the market structure continuum and the information should give you some reference points as to where the adjacent markets of Monopoly and Perfect Competition occur. Those two (2) are at opposite ends of the four (4) main market structure types on the continuum.
We will look more closely at Competitive Structure versus Competitive Behaviour as we consider and focus on Monopolistic Competition in this topic. We will consider Oligopoly market structure in the next topic (Topic 6).
Monopolistic competition
Monopolistic competition is one of the major market types that economists analyse to understand decisions by individuals and households, taking a microeconomic perspective such as the market for bath towels. Then at a national and international scale, with the introduction of government interventions such as taxes, tariffs, subsidies, imports, and exports, we can step up to a macroeconomic perspective, such as the market for new cars.
The structure of a market refers to the number of firms in the market, their market shares, and other features that affect the level of competition in the market. Market structures are distinguished from each other mainly by the level of competition that exists between the firms operating in the market.
It is not automatic that the more the suppliers, the more the competition (Goodwin et al. 2014). The nature of the market considers such factors as barriers to entry – for example, opening a new bank is very regulated by the government. Whereas opening a new airline is hugely expensive, these are barriers to new entrants joining a market compared to those already competing. For more information on barriers to entry, see renowned Harvard Professor Michael E Porter and his 5 Forces model (Magazine 2008).
Competitive structure versus competitive behaviour
Economic theory also looks at firms' behaviour, or conduct, their performance, and the level of contestability in the market. For example, a market might have an uncompetitive structure, with only a small number of firms competing, but the behaviour of firms might be highly competitive. As is the case in the United Kingdom and Australia with the supermarket sector; a few supermarkets behave in a highly competitive fashion.
The competitiveness of some firms can be to the level of industrial espionage and poaching other companies' staff, infringing trademarks, making various comparisons, accusations, and negative comments in competitive advertising campaigns. In monopolistic competition, many products may appear and seem to be very similar from the different suppliers. It only takes a glance in a supermarket to see many kinds of soft drink, bottled water, bread or milk to see how brand name goods and differentiation is what companies use in monopolistic competition to achieve optimal efficiency and profits.
Market structures are classified in terms of the nature of competition, including the absence of competition in the market. When competition is absent, the market is said to be concentrated. There is a spectrum, from perfect competition to pure monopoly (EconomicsOnline n.d).
In monopolistic competition, with many similar products, such as the highly competitive markets for wine, hotels, deodorant, and many other products and services, differentiation is paramount to survival and profit for every firm.
The monopolistically competitive firm must weigh up its available resources and consider the nature of competing products and decide on its profit-maximising quantity and price in such a way to aim to develop monopolist type demand and outcomes. If a product is so strongly differentiated, it may command a greater level of profit through marginal revenue exceeding marginal cost at an efficient equilibrium. Of course, we know we must consider short-term and long-run equilibrium.
It is a failure of the business if it achieves significant profits strong demand and yet does not last an entire year because it was inefficient and unable to sustain the costs of production at the equilibrium in a market. This often happens, especially in Fast-Moving Consumer Goods (FMCG) markets. For example, when a tenth type of men’s deodorant is launched on the supermarket shelf but is not particularly differentiated on product features or price, it may not be profitable enough to survive in a monopolistic competition market.
A competitive structure allows for many suppliers, similar prices, less differentiation, and more price competition. In these conditions, the market structure forms the competitive forces.
Examples of competitive behaviour
In the following examples of advertising commercials, we see competitive behaviour where various suppliers act themselves directly to differentiate against the competition, based on some feature it can advertise effectively. Watch the following three (3) videos to get a sense of the nature of competitive behaviour in the market for these products/services.
Energizer vs Duracell
Pepsi Taste Test Commercial
Differentiation in monopolistic competition
Consider the nature of effective differentiation with regards to the market for cars.
The four (4) indicators of monopolist competition are:
- A large number of firms.
- Differentiated products.
- Firms compete on product quality, price, marketing, and branding.
- Firms are free to enter and exit.
Are these market structure conditions present for cars?
- Yes! Australia has one of the highest per capita ranges of cars in the world.
- Yes! Have you ever lost your car in a large car park and walked past dozens of similar but different cars?
- Yes! Will the price, quality, and brand of your first ever car be the same as a car you may buy at age 45?
- Yes! Car manufactures have come and gone from the Australian market, and the range of suppliers continues to change.
But just how differentiated is the market?
For our next learning task, let us take a closer look at just four (4) examples of cars available to understand the market conditions for each car if they are differentiated. It may be that none of these cars is anything like a car you may drive or ride in at times. Yet they are all available today… at a price!
Learning task 1: Market conditions for cars
Imagine you are looking to buy a car and have narrowed it down to the four (4) cars shown in the following image slider. Click the arrows to move through the different images.
Task:
Name five (5) things that are differentiated between these four (4) cars.
Prepare your answer in your reflective journal and be ready to discuss your answers during the scheduled seminar.
You can access the reflective journal by clicking on ‘Journal’ in the navigation bar for this subject.
Learning task 2: Monopolistic competition
Part 1:
Identify two (2) different products or services available in markets today which you believe are monopolistic competitions.
One of your chosen products/services should be one that competes on differentiation through advertising its brand successfully. The other product/service should be one that competes primarily in differentiating its price (either high or low). The two products/services do not have to be in the same market or product type. Record your answers in your reflective journal.
Part 2:
Government policy influences microeconomic choices and macroeconomic outcomes, and governments worldwide have different views on how they treat the different types of economic market structures. In some cases, a monopoly is illegal. In some cases, a government will force a very large company to break up its operations, so it is not able to act as an effective monopoly. Microsoft Corporation was one such instance. There are some suggestions this situation of a single technology company having great market power may be arising for a certain large search engine beginning with G!
Task: Read the CNBC online article DOJ case against Google has strong echoes of Microsoft antitrust case to understand how some governments may act to reduce market power.
Learning task 3: Discussion forum activity
Complete the following task in the discussion forum. You can also navigate to the forum by clicking on ‘ECO100 Subject Forum’ in the navigation bar for this subject.
Market power
While the CBNC article in the previous learning task is an example from corporate America, regulators in various countries, including Australia, take a particular interest in observing if a company has ‘market power’ in any market.
In Australia, various company mergers will be prevented by government regulators, if it will lessen competition and would allow one firm to act with significant market power – or like a monopoly. This most often relates to the firm’s ability to set prices. In a majority of market structures no one firm has the market power to set a preferred price, due to the price pressure of demand for lower priced similar products/services. Later we will see in perfect competition and oligopoly markets, that no one firm can set the prices for a market. Instead, of many firms compete and prices move as a market.
The national and international economy is comprised of instances of several market types. We take a look in later topics, at macroeconomics that considers aggregate demand, aggregate supply, interest rates and so on. There is an interplay between the microeconomics of one market type and the more granular one product market, all combining to form a national or international economy with macroeconomic dynamics.
Marginal revenue and marginal cost
We seek to understand where suppliers reach an equilibrium point of optimal supply, price and profit from changes in quantity supplied.
The pressure for companies to compete in any market structure (except for a monopoly) can have short-term and long-term implications. We see sales, discounts and countless offers to buy, in week to week ‘specials’ from hundreds of businesses. What are they aiming to do? Just sell as much as possible? Just sell at a single price? Well, like so much in economics – it depends! To better illustrate, let us look in more detail at the dynamics.
Watch the following video to further understand the law of diminishing marginal returns and the impact of marginal revenue minus marginal cost.
Learning task 4: Reflective question
Having watched the previous video on marginal cost and marginal revenue, reflect on the following question:
At which point on the curve is optimal profit shown, with consideration of marginal revenue and marginal cost?
Is it Q1, Q2, Q3 or Qe? Review the previous videos and prescribed text chapter if you are unsure.
Note: If you are still unclear, go back through the pre-seminar learning tasks and be ready to ask questions during the scheduled seminar.
Law of diminishing return
These are the key elements in developing your understanding of the law of diminishing returns and to better understand the nature of competition in a monopolistic competition market. In essence, the aim is to understand how competition in such a market causes firms to compete on price and differentiation in order to sell more at a profit.
The important subsequent issue is that there comes the point where this can go too far and the law of diminishing return kicks in. When marginal costs for the extra quantity sold exceed the marginal revenue of that quantity, the company will lose money if it makes and sells anymore. The return diminishes to zero. So, that is something we really should understand before any firm goes too far.
Learning task 5: Marginal revenue and marginal cost
Complete the following tasks and record your answer in your reflective journal.
- Review the data in the following table.
Number of workers Fixed amount of capital units Output units Average output per worker 2 10 32 16 3 10 60 20 4 10 100 25 5 10 115 23 6 10 126 21 7 10 133 19 - Apply the changes in the marginal revenue and marginal cost.
- Identify at the point in which (price/quantity) returns begin to diminish.
Knowledge check
Complete the following task.
Key takeouts
Congratulations, we made it to the end of the fifth topic! Some key takeouts from Topic 5:
- Several major different market types occur.
- The way in which an individual supplier can operate and be successful is influenced and constrained by the market structure conditions. Monopolistic competition is between many suppliers of similar but differentiated products/services and is a very common market structure.
- Supply, price and demand remain the key factors, but the number of suppliers and the degree of differentiation become more pivotal.
- Customers or individuals make informed choices about substitutes and the nature of differences between products as they seek to maximise the value exchange.
- The effect of customers seeking value reinforces the core economic concept of efficiency of markets in allocating resources.
Welcome to your seminar for this topic. Your lecturer will start a video stream during your scheduled class time. You can access your scheduled class by clicking on ‘Live Sessions’ found within your navigation bar and locating the relevant day/class or by clicking on the following link and then clicking ‘Join’ to enter the class.
Click here to access your seminar.
The learning tasks are listed below. These will be completed during the seminar with your lecturer. Should you be unable to attend, you will be able to watch the recording, which can be found via the following link or by navigating to the class through ‘Live Sessions’ via your navigation bar.
Click here to access the recording. (Please note: this will be available shortly after the live session has ended.)
In-seminar learning tasks
The in-seminar learning tasks identified below will be completed during the scheduled seminar. Your lecturer will guide you through these tasks. Click on each of the following headings to read more about the requirements for each of your in-seminar learning tasks.
For this learning task, we will review your answers from the pre-seminar learning task 1. Therefore, ensure you have your answers ready for the following questions, which have been repeated from the pre-seminar learning task.
Most consumers make many regular monopolistic competition purchases. As a consumer, identify two (2) different products you regularly buy/use (at least monthly) that are in a monopolistic competition market.
- Which brand and type of product do you buy?
- What is it about that product in that market that determined your choice?
- To what extent do you often consider the similar products also offered in the monopolistic competition market?
At this point, you will have completed Learning task 1: Market conditions for cars, in which you will have named five (5) things that are differentiated between these four (4) cars. Share your answer in the seminar.
Think about what are the meaningful aspects of differentiation that give the cars different value to you.
Hint: your perspective may be different to other students but equally valid.
This task is based on Learning task 4: Marginal revenue and marginal cost. Be ready to discuss the following question:
- What is the point you can identify where returns diminish?
Welcome to your post-seminar learning tasks for this week. Please ensure you complete these after attending your scheduled seminar with your lecturer. Your lecturer will advise you if any of these are to be completed during your consultation session. Click on each of the following headings to read more about the requirements for each of your post-seminar learning tasks.
In your reflective journal, identify the advantages a consumer will have for the wide range of differentiated products in the following markets:
- Bread
- Milk
- Soft drink.
Discuss which of these three (3) markets you believe should have more choice, less choice, the same range of choices?
Review the learning tasks for this topic in preparation for your Assignment 1 quiz.
Each week you will have a consultation session, which will be facilitated by your lecturer. You can join in and work with your peers on activities relating to this subject. These session times and activities will be communicated to you by your lecturer each week. Your lecturer will start a video stream during your scheduled class time. You can access your scheduled class by clicking on ‘Live Sessions’ found within your navigation bar and locating the relevant day/class or by clicking on the following link and then clicking 'Join' to enter the class.
Click here to access your consultation session.
Should you be unable to attend, you will be able to watch the recording, which can be found via the following link or by navigating to the class through ‘Live Sessions’ via your navigation bar.
Click here to access the recording. (Please note: this will be available shortly after the live session has ended.)
- Chapter 12 of Dean, E, Elardo, J, Green, M, Wilson, B & Berger, S 2017, Principles of microeconomics - scarcity and social provisioning, Open Oregon Educational Resources.
- Chapters 9-10 of Greenlaw, SA & Shapiro, D 2017, Principles of economics 2e, 2nd edn., OpenStax.
- Chapters 10-11 of McConnell, C, Brue, S & Flynn, S 2011, Economics: Principles, problems, and policies, 18th edn., McGraw-Hill.
References
- Classic TV Ads 2006, Energizer vs Duracell 2006, streaming video, youtube, https://www.youtube.com/watch?v=0l023ewk10Q
- Dean, E, Elardo, J, Green, M, Wilson, B & Berger, S 2017, Principles of microeconomics - scarcity and social provisioning, Open Oregon Educational Resources.
- EconomicsOnline n.d., Market structures, Critic Capital LLC, https://www.economicsonline.co.uk/business_economics/competition_and_market_structures.html/
- Goodwin, N, Harris, JM, Nelson, J, Roach, B & Torra, M 2014, Principles of economics in context, 1st edn., Routledge.
- Greenlaw, SA & Shapiro, D 2017, Principles of Economics 2e, 2nd edn., OpenStax.
- GrubcoTV3 2008, Pepsi taste test commercial (1983), streaming video, youtube, https://www.youtube.com/watch?v=v7lw_vhxtNc
- Lobsey, S 2013, Marginal cost and marginal revenue, streaming video, YouTube, https://www.youtube.com/watch?v=iViIC3A3rr8
- Magazine 2008, The five competitive forces that shape strategy, Harvard Business Review, https://hbr.org/2008/01/the-five-competitive-forces-that-shape-strategy
- Mankiw, NG 2016, Principles of microeconomics, 8th edn., Cengage Learning Custom Publishing.
- McConnell, C, Brue, S & Flynn, S 2011, Economics: Principles, problems, and policies, 18th edn., McGraw-Hill.
- One Minute Economics 2019, The Law (or principle) of diminishing marginal returns (or Productivity), streaming video, YouTube, https://www.youtube.com/watch?v=lt6LpwBNSlM
- Roseoff, M 2020, DOJ case against Google has strong echoes of Microsoft antitrust case, CNBC, https://www.cnbc.com/2020/10/20/doj-case-against-google-has-strong-echoes-of-microsoft-antitrust-case.html
