Perfect competition and monopolistic competition compared

¶ … Firm, Labor Markets, and Imperfect Information

Economics

Perfect Competition and Monopolistic Competition

A perfectly competitive market does not have barriers to entry or exit and is characterized by many producers and many consumers, all of whom are price takers -- a term that means the suppliers and the buyers cannot effect the price as they do not have market power ("Competitive Markets," 2014). Monopolistic competitive markets are do have some barriers to entry and exit. Consumers can find substitutes for all of the goods in a competitive market, whereas high product differentiation is seen in a monopolistic competitive market ("Competitive Markets," 2014). Indeed, one of the reasons that a firm can achieve a monopoly for a product is that the business has been successful in its efforts to differentiate a product, as perceived by its customers. The ability of a business to make profits in the long-run is referred to as the elasticity of demand. Perfectly competitive and monopolistic competitive markets both demonstrate elasticity of demand in the long-run ("Competitive Markets," 2014). That is to say that consumers in both markets are sensitive to price, so that the demand for products decrease if the prices rise ("Competitive Markets," 2014).

A small difference in elasticity between the two types of competition does exist. Consider that in a perfectly competitive, the demand curves are perfectly elastic: an incremental price increase causes the demand for a product to cease ("Competitive Markets," 2014). In contrast, demand curves are not perfectly elastic in monopolistic competition. Businesses have market power in monopolistic competition, which means that these firms can raise their prices and not see all of their customers vanish ("Competitive Markets," 2014). A perfectly competitive market is perfectly efficient. What this means is that the profit of any firm in a competitive market cannot increase without reducing the profit of another ("Competitive Markets," 2014). This is because consumers can select substitute products without loosing any advantage or without having to pay more for the substitute good. Suppliers cannot determine the price of a product or service because the market dictates the price in a competitive market.

Cost, Profit, and Production

When prices fall, consumers will generally buy more of a good or service; this is reflected in a downward sloping demand curve ("Zero Profit Equilibrium," 2014). Alternately, an upward sloping supply curve represents the willingness of producers to sell less goods or services when prices fall ("Zero Profit Equilibrium," 2014). Market equilibrium is the represented by the intersection of these two curves -- and it is considered to be the optimal outcome for all actors in the market ("Zero Profit Equilibrium," 2014). In a monopolistic market, output is lower than it is in a competitive market, and the prices in the monopolistic market are also higher ("Zero Profit Equilibrium," 2014). This creates what is known as deadweight loss or a welfare loss for society ("Zero Profit Equilibrium," 2014). This is a primary reason why monopolies generally do not create the best situations for societies.

Businesses try to maximize revenue while simultaneously minimizing costs. This requires a business to keep an eye on changes in both revenue and costs, which is referred to as "looking at the margin" ("Zero Profit Equilibrium," 2014). That is to say that the businesses scrutinize marginal revenue -- changes in revenue -- and marginal costs -- changes in costs, for every unit produced ("Zero Profit Equilibrium," 2014). The relationship that is pivotal to profit maximization is this: If the increase in revenue is larger than the increase in costs, then producing more of the goods or services will still raise the price ("Zero Profit Equilibrium," 2014). This relationship will continue until the marginal revenue (MR) equals the marginal cost (MC) ("Zero Profit Equilibrium," 2014). Another way of showing profit maximizing is: MR=MC ("Zero Profit Equilibrium," 2014). All other things remaining the same, it will be easier to create profit in the short-term rather than over the long-term. Indeed, economic theory suggests that firms cannot be profitable over the long-term. However, what is referred to as profitability is not accounting profitability, but this is just the difference between total costs and total revenue -- or explicit costs that generate an increase in debt or an outflow of money ("Zero Profit Equilibrium," 2014). On the other hand, economic profit is total revenue minus total costs, which means that it includes implicit costs ("Zero Profit Equilibrium," 2014). So in addition to opportunity costs, economic profit also must account for the effort, money, and time that an owner invests in a business ("Zero Profit Equilibrium," 2014). In the long-run, then, owners will need to be compensated for their opportunity costs. Over the long-run, in order to have an economic profit, a business will need to demonstrate positive accounting profit with regard to the amount of the opportunity cost the business has accrued ("Zero Profit Equilibrium," 2014). The normal profit must be at least the minimum needed for production (i.e., capital, labor, materials, etc.).

Pricing Strategy

The typical pricing strategy used by movie theaters shows different admission charges for people of different ages and with particular status, such as senior citizens or high school and college students. In addition, lower admission charges are associated with matinee or afternoons showings of films. This pricing strategy is not based on whimsy or altruism, but instead reflects the primary target audience of movie theaters. Most of the people who attend movie theaters today are young males -- Gen Xers or Millenniums -- since this is the group with the freedom and discretionary dollars to make movie-going an easy and frequent decision. Sporadic and limited releases of "chick flicks" or romantic movies also attract audiences in this young age group, generally, along with women of all ages. Hollywood grinds out films for this most lucrative audience.

Consider that many elderly film buffs do not like to drive at night, so they tend to view films in the afternoons. Also note that elderly people may have compromised hearing or more stringent behavioral standards than people in other demographics; this may cause them to avoid the date night younger crowd who may be raucous and noisy. Elderly people may find that, even though children take a while to settle down at the theater, they are mostly accompanied by adults who will press for quiet, attentive behavior from their youngsters, in part to feel like they are getting the money's worth and in order to not be embarrassed by unruly children. Additionally, fewer elderly people go to movie theaters compared to the teen and young adult market. Given these factors, reduced admission fees for senior citizens makes sense -- and does not overly impact the profitability of the theater business.

Fewer films are made for audiences of children and families to attend together; when family films are released, they very often take place during school holidays, which encourages attendance. Ticket sales for new releases of films for kids and families generally reach high levels immediately, and if the film achieves a good early reputation, box office sales climb and the sheer number of people buying tickets for a movie for kids and families makes up for any gain that might be achieved by charging an adult fee, especially given the short window for trying to maximize the profit. In economic terms, consumer demand is likely to drop if prices are uniform for all age-based and status-related groups. Moreover, film buffs today can easily substitute a theater-based film experience with streaming videos at home, or buying or renting DVD movies very shortly after their release.

Insurance Policies

Adverse selection is a phenomenon in which people who work in dangerous jobs or are inordinately exposed to risk due to their lifestyles buy life insurance, or in which people who have greater risk of getting some disease because of inherited tendencies or a prevalence in their genetic lines purchase robust insurance policies. The key driver is that the insurance buyers in this situation tend to have information that the sellers of insurance do not -- at least immediately (Chiappori & Salanie, 2000). However, by requiring insurance consumers to undergo physical exams to determine their overall health, the insurance company attempts to gain access to more perfect information -- or to reduce information asymmetry by at least obtaining the same information that the buyer in the insurance market has available (Cardon & Hendel, 2001). Typical strategies of insurance companies to reduce the probability that they will have to pay out large claims include charging higher premiums or establishing particular limits to the coverage offered by the insurance company (Polborn, et al., 2006).