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Monopolistic competition

In a monopolistically competitive market, firms can behave like monopolies in the short run, including by using market power to generate profit. In the long run, however, other firms enter the market and the benefits of differentiation decrease with competition; the market becomes more like a perfectly competitive one where firms cannot gain economic profit. In practice, however, if consumer rationality/innovativeness is low and heuristics are preferred, monopolistic competition can fall into natural monopoly, even in the complete absence of government intervention. In the presence of coercive government, monopolistic competition will fall into government-granted monopoly. Unlike perfect competition, the firm maintains spare capacity. Models of monopolistic competition are often used to model industries. Textbook examples of industries with market structures similar to monopolistic competition include restaurants, cereal, clothing, shoes, and service industries in large cities.

Monopolistically competitive markets have the following characteristics:

• 
  There are many producers and many consumers in the market, and no business has total control over the market price.
  
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  Consumers perceive that there are non-price differences among the competitors' products.
  
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  There are few barriers to entry and exit.
  
• 
  Producers have a degree of control over price.
  

Major characteristics

There are six characteristics of monopolistic competition (MC):

• 
  Product differentiation
  
• 
  Many firms
  
• 
  Free entry and exit in the long run
  
• 
  Independent decision making
  
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  Market Power
  
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  Buyers and Sellers do not have perfect information (Imperfect Information)
  

Perfect market

In economics, a perfect market is defined by several conditions, collectively called perfect competition. Among these conditions are

• 
  Perfect market information
  
• 
  No participant with market power to set prices
  
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  No barriers to entry or exit
  
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  Equal access to production technology
  

The mathematical theory is called general equilibrium theory. On the assumption of Perfect Competition, and some technical assumptions about the shapes of supply and demand curves, it is possible to prove that a market will reach equilibrium in which supply for every product or service, including labour, equals demand at the current price. This equilibrium will be a Pareto optimum, meaning that nobody can be made better off by exchange without making someone else worse off.

Another characteristics of a Perfect Market is normal profits, just enough to induce enough participants to stay in the market to satisfy customer demand. The least efficient producer may have very small profits, and be unable, for example, to pay dividends to shareholders, while more efficient producers have larger profits.

General equilibrium theory

General equilibrium theory is a branch of theoretical economics. It seeks to explain the behaviour of supply, demand, and prices in a whole economy with several or many interacting markets, by seeking to prove that a set of prices exists that will result in an overall equilibrium, hence general equilibrium, in contrast to partial equilibrium, which only analyzes single markets. As with all models, this is an abstraction from a real economy; it is proposed as being a useful model, both by considering equilibrium prices as long-term prices and by considering actual prices as deviations from equilibrium.

General equilibrium theory both studies economies using the model of equilibrium pricing and seeks to determine in which circumstances the assumptions of general equilibrium will hold.

Marginal product of labour

In economics, the marginal product of labour also known as MPL is the change in output that results from employing an added unit of labour

Definition

The marginal product of a factor of production is generally defined as the change in output associated with a change in that factor, holding other inputs into production constant.

The marginal product of labour is then the change in output (Y) per unit change in labour (L). In discrete terms the marginal product of labour is

.

In continuous terms the MPL is the first derivative of the production function:

.

Graphically the MPL is the slope of the production function.

Examples

Marginal product of labour table.

There is a factory which produces toys. When there are no workers in the factory, no toys are produced. When there is one worker in the factory, six toys are produced per hour. When there are two workers in the factory, eleven toys are produced per hour. There is a marginal product of labour of 5 when there are two workers in the factory compared to one. When the marginal product of labour is positive, this is called increasing marginal returns. However, as the number of workers increases, the marginal product of labour may not increase indefinitely. When not scaled properly, the marginal product of labour may go down when the number of employees goes up, creating a situation known as diminishing marginal returns. When the marginal product of labour becomes negative, it is known as negative marginal returns.

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