Question 1. Define monopolistic competition market and give some examples found in Robe Town.

Identify the perfectly competitive and monopoly market characteristic in monopolistic

competition market.
In monopolistic competition there are many firms selling a differentiated product or service. It is
a blend of competition and monopoly. The competitive elements result from the large number of
firms and the easy entry. The monopoly element results from differentiated (i.e., similar but not
identical) products or services.
In monopolistic markets, the firms must choose a price knowing that the consumer has many close
substitutes to choose from. If the price is too high, in view of the consumer’s perception of the
value of the differentiating features of the firm’s products, the consumer will purchase a
competing firm’s product instead.
Monopolistic competition is so called because it has elements of both monopoly and pure
competition. The firm has a significant amount of monopolistic pricing and pure competition. The
firm has a significant amount of the monopolist’s pricing power by virtue of the differentiation of
its product. It can change price up or down without experiencing the extreme response of pure
competition. For price increases it will suffer a loss of sales, but this loss is not total, as it would be
for the pure competitor. Like a monopoly, the monopolistic competitor can adjust the price
upward or downward to the level which maximizes its profits. But, like the pure competitor, the
monopolistic competitor has many rivals in the short run, compounded by the free entry of new
firms in the long run.
In reality, monopolistically competitive markets are found where a large number of vendors gather
to sell similar products to a gathering of potential buyers. The weekly fruit and vegetable market
in some communities may be characterized as monopolistic competition.
Monopolistic competition is the type of market structure where there exists monopoly on one side
and perfect competition on other side. It is mixture of monopoly and perfect competition.
Characteristics/features of monopolistic competition are:
I. Large number of firms: In a Monopolistic competition there is relatively large number of
firms each satisfying a small share of the market demand for the product. As there are
large number of firms there exists stiff competition between them. But the size of the firm
will be relatively small.
II. Product Differentiation: In a Monopolistic competition the products produced by various
firms are not identical but slightly different from each other, which means the products
are not same but are similar and hence their prices are not much different. They are close
substitutes of each other.
III. Selling Cost: Firms in Monopolistic competition incur expenditure to promote sales,
which is called as ‘Selling Cost’. Selling cost is incurred in the form of advertisement

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 like on T.V., Radio, Press, Exhibitions, free samples etc. Selling cost tries to influence
consumers demand and promote sales.
IV. Free entry and exist: In a Monopolistic competition it is easy for the new firms to enter
and the existing firm to leave it. Free entry means that when in the industry existing firms
are making supernormal profit new firms enter in the industry and the losses will compel
them to leave the industry or group.
V. Absence of Interdependence: Under Monopolistic competition firms are large but not
their size. They are too small. It means every firm has its own policies like production,
output, price policy etc. Thus, the policy of an individual firm cannot influence the
policy of other firms which means all firms are independent but not interdependent.
VI. Concept of Group: In Monopolistic Competition the word ‘industry’ loses its significance
as Prof. Chamberlin has used the word ‘Group’ which means number of producers
whose goods are fairly close substitutes.
VII. Nature of Demand Curve: - In a Monopolistic competition the demand curve slopes
downward from left to right, which an individual firms can sell more by lowering price. DD
curve of monopolistic always slopes negatively.
Monopolistic competition involves many firms competing against each other, but selling products
that are distinctive in some way. Examples, in Robe Town include stores that sell different styles
of clothing; restaurants or grocery stores that sell a variety of food and drinks that may be at least
somewhat similar but differ in public perception because of advertising and brand names. i.e.,
Tokuma International Hotel.
Question 2. Distinguish the real and imaginary product differentiation in monopolistic competition
market. Is advertising a good or a bad things from societal point of view? Discuss it briefly.
Product differentiation may be real or imaginary and can be created through advertising. However,
the availability of close substitutes severely limits the “monopoly” power of each firm.
A firm can try to make its products different from those of its competitors in several ways: physical
aspects of the product, location from which it sells the product, intangible aspects of the product,
and perceptions of the product. We call products that are distinctive in one of these ways
differentiated products.
Physical aspects of a product include all the phrases you hear in advertisements: unbreakable
bottle, nonstick surface, freezer-to-microwave, non-shrink, extra spicy, newly redesigned for your
comfort. A firm's location can also create a difference between producers. For example, a gas
station located at a heavily traveled intersection can probably sell more gas, because more cars
drive by that corner. A supplier to an automobile manufacturer may find that it is an advantage to
locate close to the car factory.
Intangible aspects can differentiate a product, too. Some intangible aspects may be promises like
a guarantee of satisfaction or money back, a reputation for high quality, services like free delivery,
or offering a loan to purchase the product. Finally, product differentiation may occur in the minds
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of buyers. For example, many people could not tell the difference in taste between common
varieties of ketchup or mayonnaise if they were blindfolded but, because of past habits and
advertising, they have strong preferences for certain brands. Advertising can play a role in shaping
these intangible preferences.
The concept of differentiated products is closely related to the degree of variety that is available.
If everyone in the economy wore only blue jeans, ate only white bread, and drank only tap water,
then the markets for clothing, food, and drink would be much closer to perfectly competitive. The
variety of styles, flavors, locations, and characteristics creates product differentiation and
monopolistic competition.
A monopolistic firm produces close substitute products and therefore each firm in
order to attract consumers towards their product and increase their market share invests
heavily on advertisement. It may result in increase in profits. Firms that sell highly
differentiated consumer goods such as perfumes, soft drinks etc. spend between 10 to 20 % of
revenue on advertising.
The Critique of Advertising: It is criticized that firms advertise in order to influence
consumer’s tastes. Much advertising is psychological rather that informational.
Example. Advertisement of a brand of wrist watch. The advertisement shown in
newspaper and television does not tell the viewer about the price or quality of product.
Instead it might show a group of youngsters wearing the watch in their friends’ groups and
they make impression on others. The goal of the advertisement is to convey a subconscious
massage “You too can impress others and be happy, if only you wear our product” Critics
says that such an advertisement creates a desire in the consumers unnecessary and increases
the completion in the market.
The Defense of Advertising: Defenders of advertisement says that firms use
advertising provides information to consumers. Advertising also conveys the message about
price of product, location of store etc. which is convenient to consumer.
Advertising makes consumers more fully informed about product and firm. In
addition advertisement allows new firms to enter more easily because advertisement gives
entrants a way to attract customers from competitors
A firm can try to make its products different from those of its competitors in several ways: physical aspects
of the product, location from which it sells the product, intangible aspects of the product, and perceptions
of the product. We call products that are distinctive in one of these ways differentiated products.

Physical aspects of a product include all the phrases you hear in advertisements: unbreakable bottle,
nonstick surface, freezer-to-microwave, non-shrink, extra spicy, newly redesigned for your comfort. A firm's
location can also create a difference between producers. For example, a gas station located at a heavily
traveled intersection can probably sell more gas, because more cars drive by that corner. A supplier to an
automobile manufacturer may find that it is an advantage to locate close to the car factory.

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Question 3. Assuming that all firms are face with identical cost and demand structures, compare
long run equilibrium results of monopolistically competitive market with that of perfectly
competitive one?
Perfect competition and monopoly represent benchmark cases describing the two extremes of
market models. The first consists of many buyers and sellers, whose decisions do not affect the
market price. Therefore, the firms under perfect competition are price takers. The price results of
the supply(S) and demand (D) is equilibrium. Perfect competition industry provides a standardized,
homogenous product, therewith customers do not have buying preferences. Also, customers have
perfect knowledge of market conditions and there are not restrictions on market entry or exit of
firms.
In monopoly, there is only one seller, but many buyers. Also, there are high market entry barriers,
e.g., distinctive technological advantage or legal protection. Monopolists set prices and are
therefore price makers.
Companies in monopolistic competition will earn zero economic profit in the long run. At this
stage, there is no incentive for new entrants in the industry.
Perfect competition, in the long run, is a hypothetical benchmark. For market structures such as
monopoly, monopolistic competition and oligopoly, which are more frequently observed in the
real world than perfect competition. Firms will not always produce at the minimum of average
cost, nor will they always set price equal to marginal cost. Thus, other competitive situations will
not produce productive and allocate efficiency.
Question 4. Assume that the market demand and cost functions of the duopolies are P = 140 –
0.6Q, Where Q = Q1 + Q2 and TC1 = 7q1, TC2 = 0.6q22. Given these answer the questions that follow:
A. Determine the sort run equilibrium output of each duopoly ignoring their interdependence
(with naïve assumption) and short run market price.
Given
P = 140 – 0.6Q TC1 = 7q1 TC2 = 0.6q22 Q = Q1 + Q2
 The first step is to get TR1, TR1 = pq1
TR1 = pq1 = [140 – 0.6Q] q1
= [140 – 0.6 (q1 + q2)] q1
= 140q1 – 0.6q12 – 0.6q1q2
𝜕𝜕𝜕𝜕𝜕𝜕1
 MR1 =
𝜕𝜕𝜕𝜕1
2
𝜕𝜕(140𝑞𝑞1−0.6𝑞𝑞1−0.6𝑞𝑞1𝑞𝑞2
= = 140 – 1.2q1 – 0.6q2
𝜕𝜕𝜕𝜕1
𝜕𝜕𝜕𝜕𝜕𝜕1 𝜕𝜕(7𝑞𝑞1)
 MC1= = =7
𝜕𝜕𝜕𝜕1 𝜕𝜕𝜕𝜕1
 MR1 = MC1

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 140 – 1.2q1 – 0.6q2 = 7
133 = 1.2q1 + 0.6q2 ****************** #1
.
 TR2, TR2 = pq2
TR2 = pq2 = [140 – 0.6Q] q2
= [140 – 0.6 (q1 + q2)] q2
= 140q2 – 0.6q22 – 0.6q1q2
𝜕𝜕𝜕𝜕𝜕𝜕2
 MR2 =
𝜕𝜕𝜕𝜕2
2
𝜕𝜕(140𝑞𝑞2−0.6𝑞𝑞2−0.6𝑞𝑞1𝑞𝑞2
= = 140 – 1.2q2 – 0.6q1
𝜕𝜕𝜕𝜕2
𝜕𝜕𝜕𝜕𝜕𝜕2 𝜕𝜕(0.6𝑞𝑞22 )
 MC2= = = 1.2q2
𝜕𝜕𝜕𝜕2 𝜕𝜕𝜕𝜕2
 MR2 = MC2
140 – 1.2q2 – 0.6q1 = 1.2q2
140 = 0.6q1 + 2.4q2 ****************** #2
By using simultaneous equation, we solve #1 equation and #2 equation as follow:
133 = 1.2q1 + 0.6q2
140 = 0.6q1 + 2.4q2 …… multiply by -2
-----------------------------------
Then, we get the value of q2 = 35
From equation #1
133 = 1.2q1 + 0.6(35) = therefore, q1 = 93.33

• Q = q1 + q2 = 93.33 + 35 = 128.33
• P = 140 – 0.6Q = 140 – 0.6(128.33) = 77

B. find the demand functions of the duopolies (the reaction curves or graphic solution of
Cournot’ model and draw) and the short run output levels.
 We can get Demand function of the duopolies by solving for q1 and q2,
Using equation #1 and #2
133 = 1.2q1 + 0.6q2 …… demand function for firm 1, then,
If q2 = 0, so q1 is become q1 = 110.83
If q1 = 0, then q2 = 221.67

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140 = 0.6q1 + 2.4q2 …………. demand function for firm 2
If q2 = 0, then q1 = 233.33
If q1 = 0, then q2 = 58.33
At the equilibrium each firm maximizes their own profit, but the industry profit is not maximized

C. Calculate the short run profits of each duopoly and the industry profit.
𝜋𝜋1 = 𝑇𝑇𝑇𝑇1 − 𝑇𝑇𝑇𝑇1 𝜋𝜋2 = 𝑇𝑇𝑇𝑇2 − 𝑇𝑇𝑇𝑇2
= pq1 – TC1 = pq2 – TC2
= (77 * 93.33) – (7*93.33) = 6533.31 = (77*35) – (0.6 * (35)2)) = 1960
∴ the total industry profit is the sum of the duopolies profit, so:
𝜋𝜋 = 𝜋𝜋1 + 𝜋𝜋2 = 6533.31 + 1960 = 8493.31
D. Verify the economic profit of each duopoly graphically
 The marginal revenue (MR)
𝜕𝜕𝜕𝜕𝜕𝜕1
𝑀𝑀𝑀𝑀1 = MR1 = 140 – 1.2q1 – 0.6q2
𝜕𝜕𝜕𝜕1
= 140 – 1.2(93.33) – (0.6(35)) = 7.04

MR2 = 140 – 0.6q1 + 2.4q2

= 140 – (0.6(93.33)) + 2.4(35) = 168.002

MR = MR1 + MR2 = 7.04 + 168.002 = 175.042

P = 140 – 0.6Q, but P = 77 then, Q = 105
𝜕𝜕𝜕𝜕𝜕𝜕
𝑀𝑀𝑀𝑀 = => MC1 = 7 => MC2 = 1.2(35) => Mc = 49
𝜕𝜕𝜕𝜕

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 E. Explain the relationship between output and MR in the short run.
Firm 1 has lower MR than firm 2 because q1 > q2, (93.33 > 35)
MR1 = 140 – 1.2q1 – 0.6q2 MR2 = 140 -0.6q1 – 1.2q2
MR1 = 7.04 MR2 = 168.002
F. Calculate the long run equilibrium output of each duopoly, market price, and economic
profits of each firm and the industry profit as a whole.
The long run equilibrium will occur of the point where average costs equal demand, as a result of
the oligopoly will earn zero economic profits due to cutthroat competition.
Question 5. Assume that the market demand and cost functions of the duopolies are P = 24 –
0.1Q, where Q=q1 + q2 and q1 and q2, TC1 = 0.1q12, TC2 = 0.0q22,
A. Determine the output and price of low-firm.
Profit and cost are maximized when MR = MC
P = 24 -0.1Q TR = PQ MR1 = MC1
TR = PQ = (24 – 0.1Q) Q = 24Q – 0.1Q2 MR1 = MC1, 24 – 0.2q1 = 0.2q1 => q1 = 60
𝜕𝜕𝜕𝜕𝜕𝜕
𝑀𝑀𝑀𝑀 = = 24 – 0.2Q
𝜕𝜕𝜕𝜕

TC = TC1 + TC2 = 0.1q12 + 0.05q22

𝜕𝜕𝜕𝜕𝜕𝜕1
𝑀𝑀𝑀𝑀1 = = 0.2q1 MR2 = MC2 24 – 0.2q2 = 0.1q2 => q2 = 80
𝜕𝜕𝜕𝜕1

𝜕𝜕𝜕𝜕𝜕𝜕2
𝑀𝑀𝑀𝑀2 = = 0.1q2 Q = Q1 + Q2 = 60 + 80 = 140
𝜕𝜕𝜕𝜕2

 Output (Q) = 140

 Price, P = 24 – 0.1Q = 24 – (0.1 *140) = $10
B. Calculate the profit of the low-cost firm.
𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝(𝜋𝜋) = TR – TC, TR = QP = 140 * 10 = 1400
TC = TC1 + TC2
TC1 = 0.1 * 602 = 360 TC2 = 0.05 * 802 = 320
TC = TC1 + TC2 = 360 + 320 = 680
𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝(𝜋𝜋) = TR – TC = 1400 – 680 = 720

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C. What is the profit maximizing price level the firm would like to charge but that doesn’t
realize in the market?
Profit divided by quantity = 720 / 140 = 5.14
D. Compare the profits of the price taker at its own profit maximizing output and low-cost
firm’s output and show the results a to d graphically.