MONOPOLISTIC COMPETITION

A market structure in which, several or many sellers

each produce similar, but slightly differentiated
products. Each producer can set its price and quantity
of its productions without affecting the marketplace as
a whole.
(Adapted from http://www.investorwords.com/3111/monopolistic_competition.html)

CHARACTERISTICS:
• Many Producers and Consumers in an industry.
• Consumers have clearly defined preferences – indicating that each
has his or her own ‘ideal’ needs, wants and expectation of a product.
• Producers attempt to differentiate their products from their
competitors – indicating the need for innovations; hence goods and
services are dissimilar.
• Few/ Low barriers to entry and exit.

Examples of industry in Monopolistic Competition includes automobiles, toothpaste,

furnaces, restaurant meals, motion pictures, romance novels, wine, beer, cheese, shaving
cream and many more due to economies of scale in production and for product
differentiation.

NATURE :
Monopolistically competitive firms are inefficient. (E.g. costs of regulating prices for
every product that is sold in monopolistic competition by far exceed the benefits.
Basically, in Monopolistic Competition model, firms are free to set price and quantity)

Monopolistic competition fosters advertising and the creation of brand names.

(These advertising induce customers into spending more particularly the
consumers products because of the name associated with them rather than because of
rational factors.

Such nature of the industry leads to a competitive environment

It also allows increasing returns to scale in production, and presence of

differentiated products.
 INTRA-INDUSTRY TRADE
Intra-industry trade refers to the exchange of products belonging to
the SAME INDUSTRY, or broad product group. The term is usually
applied to international trade, where the same kinds of products and
services are both imported and exported.

CHARACTERISTICS:
• Involves the exchange of differentiated products
• Take advantage of important economies of scale in production and
product differentiation. (which leads to International economies of scale –
sharp increase in international trade in products and components, setting up
of facilities abroad etc)
• Enjoys internal economies of scale present in industries.
E.g. Internal economies of scale is where the cost per unit depends on the size of an
individual firm but not necessarily on that of the industry which leads to imperfect competition.
• Stimulates innovation and benefits consumers because of the
wider range of choices available at lower prices.
(E.g. the average cost per unit lowers as the number of goods produced increases).

NATURE :
Cost efficiency & Product Quality Benefits
Economies of Scales, consumer needs and wants differs as well as
differences in consumer behaviours (in terms of expectations)

Examples on Intra Industry trade:-

1. Entrepot trade

An entrepôt - a trading centre, or simply a warehouse, where merchandise can be

imported and exported without paying import duties, often at a profit. (E.g. Instead of
having the ships to travel the entire length of a long trading route, it can chose to sell to
the entrepôt – a form of imported goods (whereby in domestic country could also be
producing relatively similar product), however, this entrepôt has the benefit of re-
selling(export) its buys at a higher price.

2. Seasonality

For example, in agricultural products, apples, which may be exported all around the
world during its growing season, but imported during its poor growing seasons in order to
meet its domestic needs.
3. Transport costs

Intra-industry trade may occur when transportation cost can be saved. Take for instance,
both country A and B are producing the same goods. Both decides to sell to Country C.
Country B is assumed to be located further away from country C as compared to Country
A. To save transport cost, Country A and B may decided to engage in an Intra-industry
trade activity whereby, Country B sell its productions as a lesser profit margin to A and A
in turn may export it at a much higher profit margin.
 WHY MONOPOLISTIC COMPETITION MODEL TO
EXAMINE INTRA-INDUSTRY TRADE?

MONOPOLISTIC INTRA-INDUSTRY
COMPETITIONS TRADE
MODEL NATURE IMPLICATIONS
1) Many firms in an • Increase in competition, lower price > more attractive
industry to engage in Intra trade- possibility to make profits by
re-exporting similar goods elsewhere, grasp potential
market share outside the domestic market.
• Enjoy economies of scales, better use of factor of
productions. By engaging in Intra-industry trade may
lead to increase production to enjoy economies of
scale, both local and oversea consumer gets to buy
cheaper products due to increase in competition.
• Many firm> more innovations as (MC Firms) tends to
differentiate own product from others. Intra-industry
trade will imply the need for repackaging of products
for the purpose of re-exporting, value +, benefits
oversea consumers.
• Greater varieties, more choices.
2) No barriers to entry • Ease of trade, potential benefits in the case where it is
and exit cheaper to import than to produce internally= intra-
industry trade takes place.
• Overall national welfare is improved, allow
competitions, decrease prices domestically, allow
domestic consumer to enjoy lower price and more
consumer goods.
• Increase consumer spending- facilitate economy
• Intra-industry trade made easier, tends to bring about
fewer social and political problems that are often
brought about by increased trade as consumers from
both countries engaging in trade tends to benefits esp.
consumers.
3) Differentiated goods • Good for Intra-trade where local consumers gets a feel
of foreign products- maybe better or more inferior.
Differences in consumer behaviour such as different
expectations, preferences and consumption capacity..
• Feed the needs of consumer who wants foreign
products, especially those who do not regard home
goods and foreign goods as identical.
 • Quality assessments and new innovations of products
are kept in mind in MC – in order to stay competitive.

MORDERN DAY EXAMPLES:-

Example of intra-industry trade: US trade with Mexico

The table below lists the top 7 exports and imports to and from Mexico for 1998. The top 3
imports from Mexico to US are Electrical machinery and equipment, vehicles, nuclear reactors,
boilers, and related items. Interestingly, the US’ top 3 exports to Mexico are also these 3
categories. The similarity of exports and imports between US and Mexico represent intra-industry
trade, giving consumers variety of choice of available products. Out of these imports and exports,
about 80% represent intra-industry trade
** additional explanation needed along the way… **
Definitions of imperfect competition on the Web:

• any market structure in which there is some competition but firms face downward-sloping demand curves
www.wwnorton.com/stiglitzwalsh/economics/glossary.htm
• It refers to a situation under which prices can be changed by one or more persons because of abnormal market
conditions or undue advantages secured by some buyers or sellers.
www.indiainfoline.com/bisc/jmfi.html

Definitions of monopolistic competition on the Web:

• the form of imperfect competition in which the market has sufficiently few firms that each one faces a
downward-sloping demand curve, but enough that each can ignore the reactions of rivals to what it does
www.wwnorton.com/stiglitzwalsh/economics/glossary.htm

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http://www.washburn.edu/sobu/dnizovtsev/200P10ans.htmlc. …allocation of resources in

both market structures is inefficient.
TRUE. The long-run equilibrium in a monopolistically competitive market corresponds
to the case when the demand curve each firm is facing is tangent to its ATC curve. Due to
the negative slope of the demand curve, such tangency never occurs at the minimum of
ATC. Hence allocation is inefficient. (It would be if the demand curve was horizontal.)
A monopolist is concerned only about profit maximization (MR=MC), and cost
minimization is not necessary. The quantity where MR=MC can be anywhere on the ATC
curve.

2. In the long run, firms in monopolistic competition

a. produce at the point where the average total cost curve is tangent to the demand curve.
b. earn positive economic profits.
c. produce at the minimum point of their average total cost curves.
d. face steeper demand curves than in the short run.
e. produce at a point where MC>MR.

> Compared to H-O model which is based on comparative advantage or differences in

factor endowments (labor, capital, natural resources and technology) among nations,
intra-industry trade is likely to be larger among industrial economies of similar size and
factor proportions (when factors of production are broadly defined)
> Socially, intra-industry trade is more readily accepted as all the nation’s factor
endowments benefit from this as compared to the strong opposition to inter-industry trade
that usually involve lower real wages and massive reallocations of labor to other
industries in industrial nations. (refer Salvadore Lecture 6 page 173 - 2nd paragraph)