SAQ 3

1. What are the important characteristics of monopolistic competitive firms? Give an

example.

Monopolistic competition is a market structure which combines elements of

monopoly and competitive markets. Essentially a monopolistic competitive
market is one with freedom of entry and exit, but firms can differentiate their
products. They have an inelastic demand curve, and so they can set prices.
Because there is freedom of entry, supernormal profits will encourage more
firms to enter the market, leading to average profits in the long term. The most
important features of monopolistic competition are :
1. A large number of firms - In a market there are a large number of sellers who
have a small share of the market. Example like There are thousands of hotels
dotted over the country, each with a certain level of local market power and
offers a slightly different experience. The cost to start a small hotel is relatively
low. For instance, a business owner may be able to take out a loan to
purchase a property, but they could leave the market relatively quickly.
2. Product differentiation - all brands try to create product differentiation to add
an element of monopoly over competing products. The product offered by the
brand does not have a perfect substitute. The manufacturer can raise the
price of the product without having to worry about losing all its customers to
other brands. While all brands are not perfect substitutes, they are close
substitutes for each other. The seller might lose at least some customers to his
competitor. Example like Clothing. Designer label clothes are about brand and
product differentiation.
3. Some influence over the price - Each firm produces a product variety which is
a close substitute of others. If a firm lowers the price of its product variety,
some customers of other product varieties will switch over to it.
4. Non-price competition like expenditure on the advertisement and other
selling costs. Sellers compete on factors other than price include aggressive
advertising, product development, better distribution, after-sale services, etc.
Sellers do not cut the price of their products but incur high costs for the
promotion of their goods. If the firms indulge in price-wars, which is the
possibility under perfect competition, some firms might get thrown out of the
market.
5. Product variation - The variation in products by various firms. A firm, under
perfect competition, does not confront this problem, for the product is
homogeneous under perfect competition.
 6. Freedom of entry and exit - Like in perfect competition, firms can enter and
exit the market freely.

2. What will happen when economies and diseconomies of scale exist?

Economies of scale are when the cost per unit of production (Average cost)
decreases because the output (sales) increases. Diseconomies of scale are when
the cost per unit of production (Average cost) increases because the output
(sales) increases. When happening economies and diseconomies of scale exist is
an It reduces the per-unit fixed cost. As a result of increased production, the
fixed cost gets spread over more output than before, and It reduces per-unit
variable costs. This occurs as the expanded scale of production increases the
efficiency of the production process for economies. Unsourced material may be
challenged and removed. The diseconomies of scale are the cost disadvantages
that economic actors accrue due to an increase in organizational size or output,
resulting in the production of goods and services at increased per-unit costs will
happen for the diseconomies of scale exits.

3. Do you agree that monopoly is always undesirable? If no, why?

I agree that a monopoly is always undesirable because a monopolistic firm can

earn a supernormal economic profit in the long run due to high barriers to entry
and the lack of competitors in the market. There is less incentive for the firm to
be efficient and lower its average costs. Hence, a monopoly is a form of market
failure because it is a price-maker. Monopolies are typically assumed to
be undesirable market structures. They are undesirable or "bad" because in this
case "bad" means less than a possible total wealth the sum of the producer and
consumer surpluses. The higher price than the equilibrium price in a competitive
market.

4. What is the Excess Capacity and Mark up for the Monopolistic Competitive
firms?

Monopolistic competitive firms operate with excess capacity because the zero-
profit tangency equilibrium occurs along the downward-sloping part of a firm's
short-run average cost curve, so the firm's plant has the capacity to produce
more output at lower average cost than it is actually producing. Excess capacity
refers to a situation where a firm is producing at a lower scale of output than it
 has been designed for. It exists when marginal cost is less than average cost and it
is still possible to decrease average (unit) cost by producing more goods and
services. Excess capacity may be measured as the increase in the current level of
output that is required to reduce unit costs of production to a minimum. Excess
capacity is a characteristic of natural monopoly or monopolistic competition. It
may arise because as demand increases, firms have to invest and expand capacity
in lumpy or indivisible portions. Firms may also choose to maintain excess
capacity as a part of a deliberate strategy to deter or prevent the entry of new
firms.
The monopoly markup is the difference between price and marginal cost. We
know that in a competitive market, the price would be equal to marginal cost.
Here in equilibrium we have price is much greater than marginal cost, that's
a monopoly markup. Two effects are going to increase the monopoly markup in
this case. Firms in monopolistic the competition operates with a positive mark up.

5. When a profit maximizing firm shut down the production in the short run?

A firm maximizes its profits by choosing to supply the level of output where its
marginal revenue equals its marginal cost. When marginal revenue exceeds marginal
cost, the firm can earn greater profits by increasing its output. The shutdown price is
the minimum price a business needs to justify remaining in the market in the short
run. A business needs to make at least normal profit, in the long run, to justify
remaining in the industry but in the short run, a firm will continue to produce as long
as total revenue covers total variable costs or price per unit more or equal to average
variable cost (AR = AVC). This is called the short-run shutdown price. The reason for
this is as follows is a business’s fixed costs must be paid regardless of the level of
output and If we make an assumption that these costs cannot be recovered if the
firm shuts down then the loss per unit would be greater if the firm were to shut
down, provided variable costs are covered.