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AGGREGATE MARKET SHOCKS: Disruptions of the equilibrium in the aggregate market (or AS-AD model) caused by shifts of the aggregate demand, short-run aggregate supply, or long-run aggregate supply curves. Shocks of the aggregate market are associated with, and thus used to analyze, assorted macroeconomic phenomena such as business cycles, unemployment, inflation, stabilization policies, and economic growth. The specific analysis of aggregate market shocks identifies changes in the price level (GDP price deflator) and real production (real GDP). However, changes in the price level and real production have direct implications for the unemployment rate, the inflation rate, national income, and a host of other macroeconomic measures.

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MONOPOLISTIC COMPETITION, CHARACTERISTICS:

The four key characteristics of monopolistic competition are: (1) large number of small firms, (2) similar but not identical products sold by the firms, (3) relative freedom of entry into and exit out of the industry, and (4) extensive knowledge of prices and technology.
These four characteristics mean that a given monopolistically competitive firm has a little bit of control over its small corner of the market. The large number of small firms, all producing nearly identical products, mean that a large (very, very large) number of close substitutes exists for the output produced by any given firm. This makes the demand curve for that firm's output relatively elastic.

Freedom of entry into and exit out of the industry means that capital and other resources are highly mobile and that any barriers to entry that might exist are minimal. Entry barriers allow real world firms to acquire and maintain above normal economic profit. Extensive knowledge means that all firms operate on the same footing, that buyers know a lot about possible substitutes for a given good, and that firms are aware of essentially the same production techniques.

Large Number of Small Firms

A monopolistically competitive industry contains a large number of small firms, each of which is relatively small compared to the overall size of the market. This ensures that all firms are relatively competitive with very little market control over price or quantity. In particular, each firm has hundreds or even thousands of potential competitors.

This number-of-firms characteristic is a sliding scale. The extent to which an industry has a large number of small firms, the more it is monopolistic competition. Industries with a smaller number of larger firms then tend to be more oligopolistic. There is no clear-cut dividing line that separates monopolistic competition from the more concentrated market structure--oligopoly. A three-firm industry is most assuredly an oligopoly. A 3,000 firm industry is most assuredly monopolistic competition. But, an industry with 30 firms could be oligopoly or monopolistic competition.

Consider this example of monopolistic competition from the Shady Valley restaurant market. Manny Mustard's House of Sandwich is one of 2,000 eateries scattered throughout Shady Valley. Each restaurant is in competition with every other. With 2,000 restaurants in total, none has a great deal of market control. If the going price of lunch is about $5, then each restaurant charges "about" $5 for lunch. Should one try to charge $10 or $20, then it will literally price itself out of the market as the quantity demanded drops to zero and customers switch to competitors.

Similar, But Not Identical Goods

Each firm in a monopolistically competitive market sells a similar product. Yet each product is slightly different from the others. The term used to describe this is product differentiation. Product differentiation is responsible for giving each monopolistically competitive a little bit of a monopoly, and hence a negatively-sloped demand curve. Differences among products generally fall into one of three categories: (1) physical difference, (2) perceived difference, and (3) difference in support services.
  • Physical Difference: This means that the product of one firm is physically different from the product of other firms. The most popular product of Manny Mustard's House of Sandwich is, for example, the Deluxe Club Sandwich. While many restaurants sell club sandwiches, Manny makes his with barbecue sauce rather than mayonnaise. It is similar to other club sandwiches, but slightly different.

  • Perceived Difference: Product differentiation can also result from differences perceived by buyers, even though no actual physical differences exist. For example, OmniGuzzle gasoline is chemically identically to Bargain Discount Fuel gasoline. However, many buyers are absolutely convinced that OmniGuzzle is a "higher quality" gasoline. This could be due to years of intense OmniGuzzle advertising that has burned the OmniGuzzle brand name into heads of the consuming public. Brand names, in fact, are a common method of creating the perception of differences among products when none physically exist. However, perceived differences work just as well for monopolistic competition as actual differences. In the minds of the buyers, it matters not whether the differences are real or perceived.

  • Support Service Difference: Products that are physically identical and perceived to be identical, can also be differentiated by support services. This is quite common in retail trade. For example, several independent stores might sell Master Foot brand athletic shoes. Buyers know that Master Foot shoes are the same regardless of who does the selling. No physical nor perceived differences exist. However, Bobby's Bunyon-Free Footware provides individual service, money-back guarantees, extended warranties, and service with a smile. Bobby's Bunyon-Free Footware sells buyers the perfect Master Foot brand athletic shoe that fits an individual's lifestyles. Mega-Mart Discount Warehouse Super Center, in contrast, has self-service shelves filled with Master Foot brand athletic shoes. Buyers must find their own sizes. Bobby's Bunyon-Free Footware is thus able to differentiate its Master Foot brand athletic shoe from those sold by Mega-Mart Discount Warehouse Super Center.
This characteristic means that every monopolistically competitive firm produces a good that is a close, but not a perfect substitute for the good produced by every other firm in the market. As such, different firms can charge slightly different prices. Manny Mustard can charge a slightly higher price for his club sandwich. OmniGuzzle can charge a slightly higher price for its gasoline. And Bobby's Bunyon-Free Footware can charge a slightly higher price for its Master Foot brand of athletic shoes.

Resource Mobility

Monopolistically competitive firms, like perfectly competitive firms, are free to enter and exit an industry. The resources might not be as "perfectly" mobile as in perfect competition, but they are relatively unrestricted by government rules and regulations, start-up cost, or other substantial barriers to entry. While some firms incur high start-up cost or need government permits to enter an industry, this is not the case for monopolistically competitive firms. Likewise, a monopolistically competitive firm is not prevented from leaving an industry as is the case for government-regulated public utilities.

Most important, monopolistically competitive firms can acquire whatever labor, capital, and other resources that they need with relative ease. There is no racial, ethnic, or sexual discrimination.

For example, if Manny Mustard wants to leave the restaurant industry and entry the retail shoe sales industry, he can do that without restriction. Likewise if the Bobby (of Bobby's Bunyon-Free Footware) wants to leave the retail shoe industry and enter the restaurant industry, he can do so without restraint. Manny Mustard and Bobby are not faced with heavy up-front investment costs, such as the construction of a multi-million dollar factory, that would prevent them from entering a monopolistically competitive industry and competing on nearly equal ground with existing firms.

Consider the story of Manny Mustard, the second of seven children born to an immigrant butcher and his lovely wife, Ivana. Assuming the butchering duties upon his father's passing, Manny aspired to be the best butcher ever to slice sirloin in Shady Valley. The invasion of OmniFoods Discount Food Stores and several similar low-priced national food chains forced Manny to reevaluate his profession. With economic profit dropping into the negative range and normal profit on the verge of vanishing entirely, Manny transformed the Shady Valley Old Country Butcher's Shop into Manny Mustard's House of Sandwich. The slabs of raw meat were replaced by Deluxe Club Sandwich (with barbecue sauce). Manny's entry into the restaurant industry was relatively easy, and relatively straightforward.

Extensive Knowledge

In monopolistic competition, buyers do not know everything, but they have relatively complete information about alternative prices. They also have relatively complete information about product differences, brand names, etc. Moreover, each seller also has relatively complete information about the prices charged by other sellers so that they do not inadvertently charge less than the going market price.

Manny Mustard, for example, knows that the going price of club sandwiches in Shady Valley is about $5.50, give or take a little. All of the sandwich buyers know that the going Shady Valley price of club sandwiches is about $5.50, give or take a little.

Extensive knowledge also applies to technology and production techniques. Every monopolistically competitive firm has access to essentially the same production technology. Some firms might have a few special production tricks (a way to slice lettuce, a secret recipe, etc.), but these differences are not major. None of the firms has a patent on a perpetual motion machine or has uncovered the secret to time travel.

Manny Mustard, for example, has all of the information needed to make his club sandwiches. This is essentially the same information available to every sandwich-slicing supplier in the industry. Manny Mustard knows that club sandwich production involves a few slices of meat, lettuce, tomato layered between slices of bread, lubricated with sauce, and toasted to a golden brown.

<= MONOPOLISTIC COMPETITION, ADVERTISINGMONOPOLISTIC COMPETITION, DEMAND =>


Recommended Citation:

MONOPOLISTIC COMPETITION, CHARACTERISTICS, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2014. [Accessed: September 2, 2014].


Check Out These Related Terms...

     | monopolistic competition | monopolistic competition, demand | monopolistic competition, efficiency |


Or For A Little Background...

     | production | short-run production analysis | market structures | elasticity | demand | market control | competition | competition among the many |


And For Further Study...

     | monopolistic competition, short-run production analysis | monopolistic competition, long-run production analysis | perfect competition | monopoly | oligopoly | product differentiation | principle of minimum differences | perfect competition, characteristics | monopoly, characteristics | barriers to entry |


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